Mapping the path for natural gas
No birthday party is complete without balloons. Beyond livening up the venue with ornamental colour, balloons are meant to be popped. Kids love the festivity and it's all in good fun. Also, balloons can be blown up, pinched tight at the stem, and then let go to rocket around the room in a spastic rush of air. That's fun too, until someone loses an eye as your mother may point out; or unless you think of it in terms of the natural gas business.
It hasn't been much of party watching shrinking natural gas sales and producing companies on the brink of bankruptcy, but in a twisted way the party may just be beginning.
Like watching an airborne balloon deflate, Canada's conventional natural gas production is declining rapidly. Just this year we've lost about 1.0 Bcf/d of production (not including production that's been shut in). Since peaking in 2006 at well over 16 Bcf/d, volumes are now down 16% or 2.5 Bcf/d. By now everyone should know that much of the incentive to drill for natural gas in the Western Canadian Sedimentary Basin (nearly all in Alberta) has dried up due to high costs followed by low prices that have plagued the domestic industry for close to three years now. The dynamic is simple: if the rigs aren't out drilling at a certain pace, the physics of the rocks take over and natural gas reserves start declining. This dynamic is irrefutable and one of the few variables that the financial markets can count on as being predictable.
But Canada's situation is not unique. Production is now declining rapidly in high-cost, conventional geological regimes in the United States too. Back in August of 2008, the rig count in conventional US regions dropped precipitously from 800 to 200. That's when the fingers let go of the American balloon. The “blow down” hasn't been too noticeable up until now, because the aggressive growth of prolific, low-cost shale gas has been able to backfill what was being lost in the conventional regions. Behind the scenes it's been an almost seamless substitution of a high-cost product with a low-cost substitute, all facilitated by new technology applied on a large scale.
In fact, this gas-for-gas substitution is nothing new. Natural gas production from the US Gulf of Mexico has been on a steep decline since 2001, dropping from 14 Bcf/d back then down to about 7.0 Bcf/d this year. During that time period growing unconventional gas volumes from the onshore Barnett Shale in Texas backfilled the blow down in the Gulf almost one-for-one. But now shale gas regions have a challenge that is twice the size of the Gulf of Mexico: backfilling the 30 Bcf/d of conventional onshore production that's now declining by an estimated 17% per year.
The billion dollar question for 2010 is whether or not unconventional gas production in now-legendary plays like the Barnett, Haynesville, Fayetteville, Woodford, Marcellus and even Canada's Montney, to name a few, will be able to collectively respond fast enough to offset estimated conventional declines in 2010 of 5.0 Bcf/d in the US, plus another 1.0 Bcf/d in Canada. Theoretically it's possible, but nobody likes to talk theory at a party. Indeed, there are many practical constraints to boosting near term production including thin cash flows, stretched balance sheets, impatient bankers, tightened service industry capacity, and the strained logistics of mobilizing oilfield equipment once the price signals are convincing enough for E&P companies to spend money again.
In the long term, beyond 2010, shale gas and other large-scale unconventional gas plays will be increasingly dominant and able to offset conventional production declines. But that's the long term. Next year, it's quite possible that only half of the expected 6.0 Bcf/d of conventional losses in North America will be replenished. It's a scenario that speaks to benchmark continental prices rising above $US 6.00/MMBtu again, all else being equal.
This coming winter will be interesting. A mild combination of a colder-than-average temperatures, a gradual recovery in industrial demand and the gravitational pull of declining conventional production have a very good chance of collectively tightening up the oversupply that the natural gas industry has been living with for over a year. I give this near-term scenario at least even odds, and in part that's why natural gas prices have been rallying recently. After all, nobody wants to miss the party.