August 20, 2001

The next gas crisis

If you thought the worst was over, get ready. Demand is up, supply is dwindling, and new finds are scarce. Here's how to hedge against the price hikes to come By ANDREW NIKIFORUK If, like the vast majority of Canadians, you are dependent on natural gas to heat your home, ponder this thermostat-shattering truth for a moment. The largest natural gas find in Western Canada in the past 25 years is now playing out in a marshy area of northeastern BC near the Alberta border. Some analysts expect the Ladyfern field to gush about a trillion cubic feet (tcf) of natural gas, which to a layman's ear might sound like a lot of burning power. But Ladyfern probably contains just enough fuel to heat all the gas-fired homes in Canada for a year or two at most. And it's a clear freak of nature. A typical new gas well, in fact, produces barely enough gas to heat 90,000 homes for a year.

Now add some more disturbing math to this natural gas picture. Canada now produces 6.2 tcf of gas a year, which just barely meets domestic and export demand. That represents about one-fifth of North America's gas consumption, which is still growing by 2% a year thanks to gas-fired electrical generation. "We need 6.2 Ladyferns a year to just keep up with gas consumption and stand still," explains Rob Woronuk, 60, a veteran Calgary gas analyst and one of the nation's independent natural gas watchdogs. "The really scary part is that we are finding a Ladyfern only every 25 years."

Anyway you look at it, the glory days of cheap natural gas at $1.50 a gigajoule are over. Even though Canadian politicians may not be fretting as dramatically as President George W. Bush about future energy supplies and prices, they probably should be. Despite the stabilization of gas prices at about $4 a gigajoule (that's double the decade average), Canadian companies still can't find enough gas to keep.

The whole demand-supply situation is so vulnerable that a major hurricane in the Gulf of Mexico or a terrorist attack, say, on the Alliance pipeline, which runs from northern BC through Alberta to Chicago, could abruptly send natural gas prices soaring back to the rude and shocking heights they reached last winter: US$10 a gigajoule. "Everything is in a crunch and has to be working 100%. We can't even afford too many plant turnarounds," says Woronuk. "We are in a dangerous situation."

To assess just how volatile natural gas prices could be over the next year, Canadian Business talked to the same group of prescient experts we interviewed last July. Astute readers will recall that, at the time, our assembled analysts and gas veterans correctly predicted the phenomenal gas hike that clobbered the continent last winter—and three months before anyone else did. Their collective advice this time around is not as simple as "buy natural gas stocks," even though that's still a pretty good idea.

After last year's price shocker, things have changed dramatically. In fact, the natural gas market has grown quirkier and murkier, and is now complicated by an enormous demand backlash as industrial and residential gas users suddenly rediscover the born-again economics of energy conservation. But the essential facts remain the same. "We are still finding less gas and consuming more," notes Calgary-based Mike Sawyer, executive director of the Citizen's Oil and Gas Council. "The fundamentals haven't changed."

Just how tenuous this math has become was driven home last month by the staid provincial regulator, the Alberta Energy and Utility Board (EUB). Its supply outlook for 2001 to 2010 predicted that conventional natural gas production in Alberta, Canada's key producer, would peak by 2003 at 5.3 tcf and therefore decline by 2% a year for the next five years. Over the next decade, Alberta will have exported or burned up about three-quarters of its potential gas reserves. It's a case of going, going, gone.

US analysts typically sum up the situation this way: "It's the geology, stupid." Alberta's richest gas fields are now mature and aging basins with little gas left. Ditto those in the US. New pools are smaller, and "new wells drilled today are exhibiting lower production rates and steeper decline rates," according to the EUB. "I'd like to see more reserves—that goes without saying," admits the EUB's top economist, Farhood Rahnama. "But the decline in reserves is just a fact of life."

That fact, and all its political and social implications, will be complicated by rising industrial demand for gas, ironically driven by the oil sands, the source of Canada's future oil supply. By 2010, the oil sands will be hogging nearly 25% of Alberta's gas production in order to fire boilers to heat the water that melts the tarry sands into usable crude. Whether that's a wise use of natural gas hasn't been debated by any political body yet. But in real numbers, it simply means less gas for George W.—and pricier natural gas for you and me.

The sobering realities will be reinforced by a much-awaited accounting of Canada's total gas resources (both onshore and offshore) due this September. That's when the Canadian Gas Potential Committee, a volunteer group of geologists and industry types, will release a 600-page report that will identify (in glowing color) what gas is left and where it is. (Unlike the efficient US Department of Energy, Canada's National Energy Board just doesn't have a handle on this crucial information.) The Alberta and BC governments have already ordered the $15,000 CD-ROM. The report, which will clearly confirm the tightness of supplies, "will make a lot of news," predicts Woronuk, one of its authors. Its data might also raise questions about the pace of development, the volume of US exports and the absence of any coherent energy policy in Canada.

Meanwhile, the situation south of the border continues to grow bleaker. In spite of record drilling throughout the US, companies aren't finding much new gas in the dry plains of southern Texas or even the Gulf of Mexico. While the US Department of Energy predicts natural gas consumption will increase by 45% by 2015, in the past year, production has grown by barely 2%.

Bush now wants to drill in national parks and on federal lands—even though the spoilage of natural monuments could squarely fail to ease the shortage. "It's like a treadmill," Skip Horvath, presidnet of the Natural Gas Supply Association, recently told The New York TImes. "You have to race faster and faster to keep it up." Martin Molyneaux, a leading gas analyst with Calgary's FirstEnergy Capital Corp., puts it a different way: "After six quarters in a row of industry going all out in Western Canada and the US, there is only one word to describe the result: disappointing."

The disappointment is somewhat heightened by the difficult nature of options available to policy-makers. Even the sunniest projections don't predict arctic gas from Alaska or the Mackenzie Delta will reach southern markets until 2008 or 2010. And the US$20-billion price tag for what many are already calling the costliest construction project in the continent's history is enough to make most pipeline promoters think thrice, let alone twice. That undertaking might well involve two separate northern pipelines that might join outside of Edmonton, as well as the construction of another Chicago-bound pipeline. But even the Mackenzie Delta's gas is no panacea. What is now accessible holds no more gas than what Canada produces every year (6.2 tcf). "Is the Delta enough?" asks Woronuk. "Hell, no."

Alternatives to natural gas are also costly and take time to develop. Although the US is looking seriously at liquid natural gas as well as coal-bed methane, the technology is expensive and the environmental ramifications formidable. The mysterious world of gas hydrates (gas locked in ice crystals in the ocean) holds the promise of offering limitless supplies, but no technology yet exists to tap them. As a result, conventional natural gas will likely remain the dominant energy source for some time to come—and at higher and higher prices.

Current prices, however, don't reflect the persistent draining of continental natural gas reserves. Thanks to a decided drop in consumption among industrial gas users, prices have stabilized somewhat after last winter's rude heights. "I was mortified when I saw US$9 and US$10 gas prices last year," admits Molyneaux. "When you quadruple the price of a commodity, there is going to be a demand backlash—and it came at us like a truck."

That truck came in three distinct styles: a US economic slowdown, mild summer weather and a revitalized conservation campaign that made a mockery of vice-president Dick Cheney's loud dismissal of energy efficiency. Last spring, after the run-up in natural gas prices, everybody from industrial plants to shopping malls started to look for ways to reduce their energy bills. Some set air conditioner thermostats higher, while others installed more energy-friendly windows. Others switched fuels. When gas prices hovered at about US$2, industries weren't terribly aware of their energy costs, says Molyneaux. "Now they are intimately aware."

To date, the big benefactors have been coal, distillate fuel oil, nuclear power and wind producers. In fact, the doubling of gas prices has made wind a viable energy competitor for the first time, as well as the continent's fastest-growing energy source. Even Jim Gray, the venerable gas explorer and chairman of Canadian Hunter Exploration Ltd., has become a champion of demand-side awareness. Last year, he was the first executive (along with J. P. Anderson of Anderson Exploration Ltd.) to warn consumers about the coming price storm. But when that torrent put gas and electricity prices at Gray's Calgary condominium through the roof, his fellow tenants, mostly oil-patch types, studiously examined their costs. After learning that the average price of powering a 100-watt lightbulb for 24 hours a day for a year had gone from $40 to $130, Gray's condo neighbors got energy wise. They even replaced a furnace that burned gas at 35% efficiency with one rated at 80%. As a result, says Gray, "our overall energy consumption has gone down by 10%. Multiply that kind of decision-making by hundreds of thousands of people and you have a tremendous reallocation of resources."

Gray now believes that kind of demand change will normalize natural gas prices at double their average (around the current $3 range) for some time to come. Such adjustments have also taken the price of Canadian Hunter stock (TSE: HTR) from a high of $46 to a low of $30 in the past six months. Gray thinks the big natural gas story for the next year will not be declining supplies, but ever more efficient gas conservation. "Energy consumption has dropped by 10% to 15% in California this year," he says. "North Americans are the most profligate and wasteful users of energy on the globe. There is a lot of room to move here." In other words, the equivalent of several untapped Ladyferns may simply be tapped by consumers as they buy more energy-efficient appliances or improve home designs. Not surprisingly, most energy efficiency experts are now booked a year in advance.

Although the conservation backlash and cool summer weather have deflated the value of key gas stocks by as much as 50% in recent months, there's lots of room for investors to do some long-term planning. Molyneaux, for example, bullishly predicts prices will rise in the second quarter of next year. That's when reduced drilling due to lower prices should highlight North America's natural gas reality: there's more demand than gas. "We won't see US$9 or US$10 prices, but we will see high fours and low fives," Molyneaux says.

Companies well leveraged to take advantage of this increase include Canadian Hunter (it has five of Western Canada's top-25 producing wells); Alberta Energy Co. Ltd. (TSE: AEC), a key Ladyfern player; and Nexen Inc. (TSE: NXY), which brought more gas onstream last year than it did in the preceding two years. Anderson Exploration (TSE: AXL) and Petro-Canada (TSE: PCA), which have both banked their futures on Mackenzie Delta reserves, also remain important gas producers.

Canadian Business readers, of course, who took our advice last year in advance of runaway gas prices partook in some spectacular profit-making. Natural Resources Canada, for instance, estimates that natural gas plant sales jumped from $12 billion in 1998 to $41 billion this year. It expects revenue to fall to $28 billion by 2005 and then climb again to $34 billion in 2010, which, by any account, amounts to more steady profit-making.

None of our experts, meanwhile, expect a repeat of last year's natural gas fiasco or what many pundits now dub "the perfect storm." The key element, of course, was declining supply. As well, US electrical power generators burned natural gas like water all last year, when drought lowered reservoirs and made hydro generation a no-go on the West Coast. As a consequence, the volume of natural gas stored underground hit all-time lows.

Oil, normally an alternative fuel for natural gas, then hit US$34 a barrel, and California, one of the continent's big energy guzzlers, started experiencing blackouts. Cold weather followed as surely as night follows day, and by then Canadians were digging deeper into their pockets to pay for the natural gas storm brewing in their furnaces. As one federal report lamented, "everything that could happen to increase prices, did happen."

This year, the elements are arrayed somewhat differently. "I don't think the situation will be replicated," says Larry Pratt, a longtime energy policy analyst in Edmonton, "even though we aren't replacing the gas we are using." Molyneaux agrees. "Once you shock people, it's hard to shock them a second and third time," he says. Both US and Canadian storage operators, for example, have now pumped gas into basins for winter usage at record levels. But winter storage is only a buffer, not a solution.

Nevertheless, our batch of clear-eyed soothsayers all agree that consumers and investors alike must carefully watch the weather. A late-summer hot spell combined with a cold winter could produce an imperfect storm—and bring gas prices back to US$6 or higher. But most don't see any major price hurricanes until supply hits another serious demand crunch—which, as we've noted, could likely come in the second quarter of next year. That's when cheap conservation fixes will exhaust their possibilities and disappointing drilling results will highlight the essential math that produced the initial storm. "The direction is clear," concludes Woronuk. "There is not enough gas left in existing basins. It's going to get worse. That means demand has to go down or supply is going to be very, very tight."

North America is still using more gas than it is finding. Concerted conservation drives and a softer economy may temporarily mask ever-dwindling supplies. A prolonged cold snap, though, could remind us of the reality sooner rather than later. You can count on rising prices to definitely affect your home and business heating bills—or your portfolio—early next year as natural gas abandons its image as a cheap staple and becomes, for better or worse, a premium good on the North American market.

http://www.canadianbusiness.com/magazine_items/2001/aug20_01_thenext.shtml

-- Martin Thompson (mthom1927@aol.com), August 19, 2001

Answers

Good morning martin, I am glad you posted this article. I found out about a friend who uses natural gas was told last week that she is still paying on her gas bill from last winter! Yes, her balance on her natural gas bill balance as of now --500.00 and another winter is just around the corner. I know there are others in this position. Thanks again martin.

-- Tess (webwoman@iamit.com), August 20, 2001.