The Future of the North American Natural Gas Industry and the Role of Western Canadian Gas,
or, Timing Is Everything
World Energy, Vol.3, No.1, 2000
by Brian F. MacNeill, President and CEO Enbridge Inc.
.pdf-version of this article: worldenergysource.com
It's a dangerous sport making public pronouncements about what our industry will look like in a month, let alone a year or a decade! It was just over a year and a half ago that the price of oil dropped below US$10 a barrel. Some very smart people believed it would drop to $5 a barrel, and other smart people suggested it might never rise again.
Just last winter, The Economist predicted oil would eventually trade at $5 a barrel. Naturally, they were wrong.
I've been around the energy patch long enough to advise against long-term, or even short-term predictions. But in the case of natural gas, I'm willing to ignore my own advice and state that the natural gas industry in North America has a rosy future, and Western Canadian gas will play an increasingly important role in that future.
Before I explain why I'm so bullish on natural gas, however, let me briefly outline where my company, Enbridge Inc., fits into the natural gas picture. Enbridge is a Calgary-based company involved in energy transportation, distribution and services in North America and internationally. A few years ago we were best known as a crude oil pipeline company - Interprovincial Pipe Line, now known as Enbridge Pipelines.
Then we added Enbridge Consumers Gas, the largest natural gas distribution company in Canada, serving 1.5 million customers in Ontario, Quebec and New York State. Today we have extended our involvement in natural gas from the wellhead to the burner tip. Through our investment in AltaGas Services we are involved in gas gathering and processing. We have expanded our gas distribution business into the province of New Brunswick, and through our investment in Noverco we are involved in Gaz M‚tropolitain and the TQM Pipeline.
As part of our west-to-east strategy for gas, we were one of the original participants in Alliance Pipeline, and we are the lead sponsor for Vector Pipeline, both of which are currently being built for start-up later this year.
Natural Gas - The Future
So where do I think our industry will go in the next few years? As I said, I'm bullish, very bullish. Here's why. In North America and around the world, the long-term outlook for natural gas market growth is excellent. Natural gas is clean burning, versatile and inexpensive relative to other fuels. Especially in major population areas of the U.S., it's underutilized. In Western Canada, it's plentiful, relatively cheap and easy to recover.
In fact, just as oil has fueled industry and commerce for the past 100 years, I believe natural gas will be the growth fuel of the next century - not only for the reasons I've listed, but also because there is a unique convergence of political, economic, technological and social developments that clearly favor natural gas as the fossil fuel of the future.
Political Developments
A key political development is the continued trend towards increased environmental regulation of industry, and the possibility of mandated emission controls, such as those envisioned as part of the Kyoto Agreement. Industry faces controls that, if enacted, will force industries and consumers to switch to cleaner burning fuels. These controls would also decrease reliance on coal-fired electrical generation, especially in the Northeastern U.S., and that would increase the costs of carbon-intensive fossil fuels like coal, oil and diesel to such an extent that consumers will switch to cleaner burning natural gas for economic reasons.
Economic Developments
Natural gas has long had a price advantage compared with other fuels. For example, in Ontario, residential customers who use natural gas paid approximately $6.75 per gigajoule in 1999. Fuel oil users paid more, about $9.25 per gigajoule, and electricity users paid a lot more, about $23.00 per gigajoule. The advantage is clearly with gas.
In the industrial sector, which accounts for over 40 percent of end-use energy demand in Canada, heavy fuel oil prices track natural gas prices much more closely, due to the high degree of substitution between the two. But here, too, gas has and is expected to maintain a price advantage.
In some regional markets there may well be price advantages for a particular fuel. For example, electric power rates in Quebec are among the lowest in North America. But overall, in terms of the large energy growth markets in Eastern Canada and the Eastern and Midwestern states, natural gas has and will continue to have a price advantage.
Then there are economic developments like the impact of electrical deregulation in Canada and the U.S. Some observers predict that the non-regulated electricity market on this continent will grow at a rate of 35 to 40 percent per year over the next five years. Most of this growth will be in the development of combined-cycle, gas-fueled plants, since these can be built quickly and they are simpler, safer, more efficient and more economic than the competition.
Certainly forecasters expect natural gas consumption for electric power generation to more than double by the year 2010 in both Canada and the U.S. In addition, many believe that electrical deregulation will uncover the actual cost of nuclear power, which, combined with the phasing out of aging nuclear plants that is already occurring, will mean increasing demand for an alternative like natural gas.
Technological developments are also giving gas a boost. Developments have improved the safety and efficiency of pipeline transportation. Additionally, advances in pipe manufacturing technology allow richer natural gas streams to move using less fuel than current systems, improving the economics even more.
Last but not least are social developments, such as increasingly sophisticated energy consumers. Sophisticated industrial and retail customers demand more economical, environmentally friendly energy. That, coupled with an increasing continental population and expanding economy, will drive the market for natural gas.
Predictions are that North American market demand will top 30 trillion cubic feet per year by 2010, up from a market of about 25 tcf in 1998. That reflects ongoing growth in existing market areas, with major increases in Eastern Canada and the Midwestern and Eastern U.S. And the major sources of that growth in natural gas use will be the industrial and electricity generation sectors. Clearly, natural gas markets are growing. The real question is, who will serve those markets?
Western Canada's Competitiveness
If you look at North America as a whole - which is an increasingly integrated natural gas market - the single biggest source of gas is and will continue to be the U.S. Southeast, specifically Texas, Louisiana and both onshore and offshore in the Gulf of Mexico.
But Western Canada is also a major player and will be a leader in serving major growth markets in Eastern Canada and the Midwestern and Eastern states because of two factors: its reserves and transportation infrastructure. The Western Canadian Sedimentary Basin is one of the world's most abundant and economical sources of natural gas and boasts some of the lowest finding and development costs of any energy supply basin in North America. In 1996, for example, the development cost in the Western Canadian Sedimentary Basin averaged under 50 cents per mcf, compared with over 75 cents per mcf in most regions of Texas and Louisiana.
At over 200 tcf of ultimate recoverable conventional gas reserves, the Western Canadian Sedimentary Basin is estimated to have the largest remaining conventional potential of any oil and gas basin in North America. Also, it's still a relatively immature basin, in terms of the amount of drilling and development that has occurred, with a lower well density than basins in the lower 48. Estimates of the amount of the ultimate recoverable resource exploited to date is only 25 percent for the Western Canadian Sedimentary Basin, versus 45 percent for the continental U.S.
Additionally, producers in Western Canada are positioned to be competitive because they have access to an existing and growing delivery infrastructure that is second to none. I'm proud to say that Enbridge is one of the companies that is working now to ensure that the appropriate transportation infrastructure is in place to capture increasing market share. We recognized the trends that will increase continental demand for natural gas, then we looked for the stumbling blocks that could delay, maybe even decrease, the growth in demand and acceptance of natural gas as tomorrow's fuel. Stumbling blocks like outdated technology and a regulatory environment that won't allow pipelines in Canada to earn the same
sort of return on equity that pipelines in the U.S. can generate, which penalize Canadian pipelines when they go to the markets for capital.
Canada's Competitors
While the outlook for growth in demand for natural gas is excellent, and the probability that Western Canada will supply the lion's share of gas for Eastern and Midwestern markets is high, Western Canada obviously isn't the only game in town. Although companies have been drilling for gas for a good many years, it's a relatively recent phenomenon for companies to concentrate on gas as much as - or instead of - oil. But that is what is happening from Texas to the Northwest Territories.
Obviously, gas is being seen in a different light. More producers now see the great potential for market growth, and they see strong and improving prices for natural gas. That, in turn, means that gas supplies will increase throughout North America, increasing competition in many markets. To succeed, Western Canadian producers will have to play to their strengths, and focus on those markets where they have the advantage.
Western Canadian producers have already been quite successful in capturing a lot of the growth in Eastern and Midwestern markets, which are and should be their focus. To continue this success, however, Western Canadian producers will have to add new reserves and deliverability. Already, the amount of gas available from the basin for new and growing markets is forecast to increase between now and 2005. Currently, supply exceeds regional demand by about 12 bcf per day. By 2005, supply should exceed demand by about 15 bcf per day.
On the other hand, in most gas-producing regions in the U.S., demand exceeds supply. And in the Southeast U.S., where supply does exceed demand, growth in demand is expected to at least keep pace with growth in supply.
The Response - Timing Is Everything
I believe the continued success of Western Canadian producers depends on timing. After all, timing is always an essential ingredient of success, and in terms of capitalizing on gas opportunities in the years ahead, it will be critical. Also critical, of course, is the ability of Western Canadian producers to deliver natural gas where it's needed, when it's needed, as economically as possible.
That is why it's so important that Canadian producers have the infrastructure to deliver their product to new and emerging markets. Without the infrastructure, Western Canadian producers will lose the market, and gas will flow from south to north, not west to east. It's as simple as that.
Western Canadian producers already have a strong, basic infrastructure, and industry is adding to it right now. I'm proud that the Alliance Pipeline will be a key part of the infrastructure necessary to meet the growing demand for natural gas because several years back, a group of 17 players in the Canadian energy industry, including Enbridge, recognized that natural gas truly was the fuel of the future, particularly in Eastern markets. We realized, too, that it was only a matter of time before everybody else saw the potential and competition became ferocious.
We also recognized a change in the way gas pipelines were built and markets were developed. Traditionally, producers have drilled and discovered gas, then identified markets, then built pipelines on the strength of firm, long-term contracts. Today, the reality with rapidly growing markets is that shorter-term contracts are the norm and pipelines are built based on anticipated market requirements.
A New Gas Paradigm
The new paradigm is that if you build pipelines to growing markets, long-term supply will follow. Put the pipelines in place and producers will drill to ensure there is sufficient deliverability to keep them full. In other words, somebody needed to go where the action would be, and we decided to do just that. Or to put it in hockey terminology, just like Wayne Gretzky, we understood the need to go where the puck would be, not where it already was.
That's essentially what happened when the TransCanada main line was first built in the 1950s. Almost a half a century ago, leaders in industry and government saw the potential for natural gas and built the infrastructure to tap that potential. Early pipeline pioneers were true visionaries - like Apple's Steve Jobs and Microsoft's Bill Gates - who developed products no one knew were needed but today are indispensable.
Unfortunately, I think the gas industry lost that pioneering spirit for a while. New pipelines were not going to be built unless sufficient reserves and sufficient deliverability could be proven to sustain long-term contracts. That's why a few years ago we looked around and realized the infrastructure in place had been crafted for the 60s and 70s, not the 90s and certainly not for the new millennium. We saw infrastructure that had been developed for yesterday's markets, not tomorrow's. We understood that new attitudes, coupled with the latest technology, would boost our ability to deliver natural gas cheaply and efficiently. So we decided that we would apply that new technology and go where we expected the demand would be.
For that reason, Enbridge was one of the original participants, along with our fellow visionaries, in the Alliance Pipeline to move Western Canadian gas to the growing Chicago market. That's also why we have taken the lead on the Vector Pipeline, to tap the gas that will be coming in to the Chicago hub and move it farther east, to meet growing demand in Eastern Canada and in the Midwestern and Eastern U.S.
Because of TransCanada, Alliance and Northern Border, as well as others, Western Canadian producers have and will continue to have one of the most efficient, economical pipeline infrastructures in the world to provide a variety of transportation alternatives to access these growing continental markets. As I said, timing is everything - and the timing of these new pipeline systems is perfect. In return, the new pipeline systems need sufficient supplies of natural gas to fill the pipe.
And that could be a fly in the ointment. The Western Canadian Sedimentary Basin has plenty of reserves, but deliverability is contingent on new drilling. It's estimated that a 1.5 percent annual increase in gas drilling is needed to achieve the supply forecasts. That is certainly achievable, if the price remains right.
As I have already said, natural gas supply has traditionally been directly related to the search for oil. At over US$25 a barrel, there will be lots of exploration activity for oil, but you don't need a long memory to remember the days of $10 a barrel. Because of those low oil prices, drilling activity in general in Western Canada fell off the past few years.
Now, gas prices are themselves high enough to warrant an increase in drilling. And with expectations for Henry Hub gas prices in the neighborhood of US$3 per million BTUs, drilling for gas will almost certainly continue to stay strong and should increase.
When Alliance and Vector come on stream, Western Canadian producers will need to supply sufficient deliverability to meet the needs of and sustain the market growth that we know is developing. If they don't, alternative sources of supply will be sought. Still, Western Canadian producers have the edge, with the lowest cost reserves and the infrastructure. They just need to provide the gas supply to meet the demand.
Conclusion
In conclusion, these factors make me bullish:
- A rare convergence of political, economic, technological and social trends has created tremendous potential for long-term growth in continental natural gas markets.
- Western Canadian geography and industry history mean that producers in this region are ready to profit from this potential now and for the foreseeable future.
- With the expansion of existing pipelines and the completion of new pipelines, the infrastructure linking this basin to key growing markets will be in place and the timing will be right to capture new market growth.
Timing will be the key to success, just as it is the essence of survival. In the words of American statistician and quality-control expert W. Edwards Deming, who lived in the early part of this century, "It is not necessary to change. Survival is not mandatory." Several years back, we at Enbridge, as well as many others, chose to change; not just to survive, but to grow and prosper. We have made a long-term commitment to natural gas and we are creating the attitudes and the infrastructure to link producers with consumers across the continent for many years to come. |
