Analysis:A new report from Canada's National Energy Board points to significant changes coming to the North American gas industry, shifts that will be felt in Mexico, the United States, and Canada.
The deliverability assessment by the NEB, Canada's equivalent to the Federal Energy Regulatory Commission (FERC), confirmed what is as evident as President George W. Bush's Texas twang—gas production in this country has peaked.
In the absence of major discoveries like Ladyfern in northeast British Columbia, volumes from the Western Canada Sedimentary Basin (WCSB), home to the vast majority of the country's gas wells, will drop to 15.9 billion cubic feet per day (bcf/d) by the end of 2004. The basin flowed 16.6 bcf/d at the close of 2001, and the study estimates the number will be down to about 16.3 bcf/d when this year's calendar is tossed into the garbage in 11 days.
The decline is coming even though gas connections (the NEB's term for any productive horizon in a wellbore, thus reflecting the impact of holes with multiple pay zones) are expected to climb from 11,000 this year to 11,500 in 2003 and 12,000 in 2004.
The forecast is based on decreasing initial production and rising decline rates. These factors are not new, first surfacing in 1996, but some recent trends in Canadian gas drilling have exacerbated the problems.
The plunge in gas prices for much of 2001 and 2002 helped increase the popularity of shallow drilling in the low-cost areas of Alberta and Saskatchewan. These holes, located on the WCSB's east side, made up 67 percent of all new connections in 2001 but only accounted for 32 percent of the basin's output. (The remaining two-thirds of daily production was evenly split between medium- and high-cost areas.)
The concentration on these low-risk but less lucrative prospects helps explain why average initial productivity per connection has fallen steadily since the early 1990s, from almost 700,000 cubic feet per day in 1991 to less than 400,000 last year.
"The initial decline rate during the first two years of production has reached 50 percent. The second decline rate, in the remaining producing life of the connection, has reached 28 percent," the study said.
The increased maturity of the WCSB translates into 2001 connections recovering less than 25 percent of the gas than a similar find made in 1995. For producers, particularly U.S companies that paid billions of dollars over the past two years to acquire gas reserves in the land of the maple leaf, this is a significant finding that needs to be worked into all exploration and development models. The past is definitely not a roadmap to the future.
The news was not all bad as NEB analysts did find some encouraging signs. Data from wells connected in 2001 indicate initial productivity from new connections has stabilized at 2000 rates. Decline rates also appear to be stabilizing. Producers have to run hard to keep from falling off the treadmill, but at least the pace is not still increasing.
While the report highlights some ignored aspects of the Canadian gas industry, such as the fact that 70 percent of the WCSB's output comes from just four of 12 sub-regions, it is more interesting because of its implications on supply-demand fundamentals.
In Canada, it should encourage producers to spend more money in high-cost areas with better production characteristics, such as the Rocky Mountain foothills in Alberta, northeastern B.C. and even the Arctic.
The focus on deeper horizons needs to become more pronounced because 3 bcf/d, based on an overall decline rate of 20 percent in the WCSB, must be found each year just to keep Canadian output flat. Producers cannot drill themselves out of the shortfall by nailing gopher shots in southeastern Alberta and southwestern Saskatchewan.
The NEB's analysis indicates the end is in sight for Canada's role as swing supplier to the U.S. market, a position in the future that will be filled by liquefied natural gas supplies or, eventually, Mexican gas.
The renaissance in LNG facilities is already well underway in the U.S. Several plants have been taken out of mothballs and some owners are even planning expansions. The best sign of the revival came this week with the FERC's approval of Dynegy Inc.'s 1.5 bcf/d LNG facility at Hackberry, Louisiana. If the proposal goes ahead, it will be the first new LNG plant in the U.S. in the past 25 years, demonstrating the sector is quite attractive at $4 per mmBtu.
The Energy Information Administration forecasts LNG imports will hit about 900 billion cubic feet per by 2010, compared with roughly 300 billion in 2001. However, this number is likely conservative, especially if electricity demand in the U.S. recovers and averages three percent growth over the next decade. The expanded and new LNG capacity will be needed to meet growing power demand since Canadian supply can no longer be easily ramped up.
Increased LNG imports along with license extensions of nuclear generating stations and coal plants (as long as they reduce emissions) should help cap North American gas prices. This would ensure that power and industrial demand don't disappear as in early 2001 when gas prices spiked above $10 per mmBtu, a factor that dragged down the commodity's value in the second half of 2001 and much of this year.
Over the longer term, Mexican gas should play a much larger role in the U.S. market. However, it won't happen for quite a few years and will need a significant political commitment from President Vicente Fox and his successors since the petroleum industry is constitutionally protected from foreigners.
There is little chance the cash-strapped federal government can afford to develop Mexico's underexploited northern gas reserves, which would help lift the country's standard of living. International petroleum companies are not going to bring their wallets, marketing skills, and technical knowledge unless they can go after the lucrative and nearby U.S. market. It's going to be a slow waltz, but the obvious benefits to both sides will eventually result in the partnering of Mexico's politicians with oilpatch executives on the same dance floor.
The NEB report will help stimulate two other developments in Canada. Coalbed methane north of the 49th parallel, still a baby compared to the more mature U.S. non-conventional gas segment, will get more attention and money from producers.
Proponents of the C$4 billion Mackenzie Delta pipeline should also take heart from the report. It will be a lot easier to sign long-term pipeline contracts knowing there is going to be ample demand for the 1 bcf/d to 1.5 bcf/d expected to flow by 2010.
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