Gas Shortage in Alberta - look in the mirror government - let us drill!
Here's an interesting article from the latest REPORT NEWSMAGAZINE which
mentions Probe and makes some very interesting observations.
RUNNING OUT OF GAS. High finding costs and steep production declines have
spooked petroleum investors. (by George Koch)
The National Energy Board (NEB) warns that the Canadian West's petroleum producers
may fail to meet their natural gas sales commitments in the near future, which, if it
happens, will be an unprecedented catastrophe. The potential fuel supply crisis is driven
by several factors: a steep decline in output from existing wells, rapidly climbing costs
for proving up new oil and gas fields, plus a shortage of capital for new drilling. In a
recent NEB report, the federal energy regulator forecasts a stunning production drop of
48 percent within two years from current natural gas wells. And despite strong prices for
oil and gas in recent months, many investors so far have refused to jump back into the
business.
The cash crunch began late in 1997 when crude oil prices plummeted, eventually
bottoming out at US$11 per barrel. Martin Molyneaux, a tough-minded analyst at
FirstEnergy Capital Corporation, monitors the cost structures of 80 petroleum companies.
In 1998, those firms lost a combined $1.65 billion. "The energy industry is notorious for
earnings returns that barely exceed the cost of capital at the best of times," Mr.
Molyneaux says bluntly. But last year earnings performance more closely resemble
internet stocks than a commodity based business that has been around for many decades."
The losses reverberated widely. Over the past year, Chevron, Shell, BP-Amoco and, two
weeks ago, Petro-Canada all announced the sale of their conventional crude oil properties
throughout western Canada. Three of the four will remain active in western Canadian
natural gas and oilsands.
The oil price decline hurt natural gas as well, because producers used their cash flow
from gas to remain solvent (banks for instance, demanded that debt levels be reduced).
Consequently, drilling levels plunged. "This industry is unique in Canada in that it
reinvests more than its cash flow every year to maintain production," says Greg
Stringham, vice-president for markets and fiscal policy with the Canadian Association of
Petroleum Producers. "So a financial slowdown has a huge impact on production and
reserves."
The cyclical price downturn, normal in itself, coincides with an unrelated trend. As
western Canada's supply basin matures, the average quality of new discoveries
deteriorates. Reservoirs become harder to spot and the volumes in new oil and gas fields
decline. Worryingly, the costs of finding and developing reserves continues to climb, a
key finding of Mr. Molyneaux's report.
A key measure of that change is the rate at which production in new wells falls off. In its
recent report on short-term deliverability, the NEB noted the average "decline rate" of
natural gas wells has climbed from 6.8 percent per year in the early 1990's to 10.3 percent
last year. In 1998, overall production of natural gas barely increased at all, despite
sharply higher sales commitments. Merely maintaining production, the NEB warned,
would require drilling some 5,000 gas wells per year, far more than were drilled in 1998.
Taking oil and gas drilling combined, only 7,400 oil and gas wells were drilled last year,
down 40 percent compared to 1997.
Even though crude oil has recovered to about US$23 per barrel and its price outlook
appears good, the urgently needed rebound in drilling may be stymied. Investors,
especially big "institutionals" such as pension and mutual funds, have buttoned up their
wallets. In fact, average share prices in the energy sector have declined since August.
"I've never seen a situation like this, where investors have simply ignored the cyclical
uptick in commodity prices," says the president of one junior producer. As a partial
explanation, the energy sector has been embarrassed by several horror stories of
companies whose own errors in judgment drove them to the financial brink. They
include Newquest, Amber, PROBE, Blue Range, Merritt and Remington, all
independents previously favoured by investors.
"It's a grim investment picture," says Michael Tims, CEO of Peters and Co., a Calgary oil
and gas brokerage. By his company's calculations, a mere $1.6 billion in new equity has
come into the oil patch this year through October, barely equal to the $1.9 billion that
was invested in the bad times of 1998. By contrast, the industry raised $8 billion in 1997
and $6.7 billion in 1996. Equally significantly, much of the capital this year has been
spent on acquisitions (which do not add to production capacity) rather than on drilling.
Yet as the basin matures, the industry is becoming even more dependent on capital. It
now requires more than $6 of capital stock to support production of one barrel of oil or
its natural gas equivalent, Mr. Molyneaux's analysis states. That cost is up by more than
50 percent over the past decade. Producers themselves seem to be responding negatively.
During 1998, the petroleum industry spent only $15.6 billion on capital projects, down
from $23.4 billion in 1997.
Raising new money remains a big problem. Some recent share issues -- for example,
Penn West, Paramount and Rio Alto -- found buyers. But the underwriters had to eat big
chunks of large equity offerings by Berkley (arguably Canada's foremost exploration
team) and Canadian Natural Resources (a great gas success story), leaving the brokerage
community distinctly nervous about further adventures.
The oil patch, however, is built on optimism. "Better oil prices are already freeing up
capital for more gas drilling," argues Rich Hillary, a veteran Calgary consultant. "My
feeling is we've got adequate supply going into the winter." Ongoing technological
improvements continue to increase the ratio of successful new wells, he notes. Strong
demand for natural gas, anticipated across North America, along with reasonable crude
oil prices, should trigger renewed drilling sooner or later.
"It's true that, in order to meet the deliverability requirement with the increase in pipeline
capacity that is coming, we have to drill more than 5,000 gas wells per year," says Mr.
Hillary. "But with the turnaround in prices, the expectations are that we may be up to
7,000 to 7,500 gas wells in 2000. That should be enough to fill the pipeline capacity
going forward."
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