As Canadian natural gas prices settle to lows not seen in 14 years, the energy sector has responded in a peculiar way: by producing a whole lot more of it.
Spot gas prices in Alberta dropped to $1.62 per million British thermal units on Tuesday, a level not seen since 1998. U.S. prices also sank, briefly hitting $2.20 (U.S.) per million BTU on Tuesday, a decade low in that country, before staging a slight recovery.
One of the key reasons behind the months-long slide in gas prices is a remarkable surge in supplies. In the U.S., natural gas output in December was up five-billion cubic feet a day over the prior year. That's a 7.5-per-cent increase at a time when demand fell by more than 6 per cent, in part thanks to an unseasonably warm winter that kept furnaces low.
In Canada, major producers have also been reporting higher output. Canadian Natural Resources Ltd. saw its gas output up 2 per cent in the fourth quarter. Encana Corp.'s rose 7 per cent. Even Royal Dutch Shell PLC saw its Canadian gas numbers climb roughly 5 per cent at the end of last year.
The disconnect is jarring, made more so by one remarkable fact: the supply of gas is growing in part because many companies are still making money. They aren't seeing anything like the torrents of cash flowing to those with oil wells today, of course. But new technology and a series of market quirks have rewarded many of those who continue pumping gas, even with prices in the basement.
The most important factor is the chase for so-called "wet" gas, which has dominated industry activity for the last few years. It's natural gas that surges to surface accompanied by liquid hydrocarbons like propane, butane and ethane. Those liquids radically shift the dynamics.
In oil terms, natural gas currently trades for under $14 a barrel. Propane, meanwhile, sells for around $50 a barrel; butane is roughly $90. At prices like that, natural gas becomes nearly an afterthought. In some wells, companies could make money even giving away the gas, which in those wet wells is called "associated gas." In others, it takes a very low gas price to make it work.
David Hobbs, chief energy strategist at IHS Cera, has calculated that over the next decade, "we can see up to 14-odd BCF [billion cubic feet]a day of associated gas that would still be economic to produce at $1."
With the U.S. currently producing 72 BCF a day, that's a large percentage.
There's more. Some companies are profiting because they aren't taking a bath on today's lows. Rather, they are selling at prices a year out, which are much stronger. Take Encana, one of the continent's largest gas producers.
Chief executive officer Randy Eresman has said "many of our resource plays [are]now trending toward sub-$3." That's money-losing territory relative to Tuesday's $2.33 closing price. But it's comfortably profitable if Encana sells against the forward strip, which is the price for gas that will be delivered in the future. On Tuesday, gas for delivery in March, 2013, sold at $3.42 per thousand cubic feet.
"Producers have driven costs out of the system to a point where new wells will be economically viable at the strip price, even if today's spot price itself looks a little on the low side," Mr. Hobbs said.
That said, Encana expects its company-wide average supply cost to sit at $3.65 this year, meaning it's no longer making money even on gas sold a year out. That has forced a major retraction. Encana slashed its 2012 capital spending by $1.7-billion, a 37 per cent cut, and expects its output to fall by 500-million cubic feet, or nearly 15 per cent.
In Canada, where distance from markets shaves 50 to 75 cents off U.S. prices, producers have been feeling more pain, and production fell just over 4 per cent in 2011. Ralph Glass, an energy economist who is director, energy valuation and operations for AJM Deloitte, has a son who works in the gas fields around Fort St. John, B.C., where "activity has come to a standstill," he said. "On the Canadian side and the U.S. side, there's been a really severe dropoff in activity on natural gas."
Yet a price recovery may still be a long time in coming. By one estimate from several months ago, some six-billion cubic feet a day of natural gas is sitting in wells that have been drilled but not yet connected to pipelines. That's production that could be turned on very quickly, and likely to suppress any rally in prices.
At the same time, gas is piling into underground storage caverns, where it can also be released very quickly. In the U.S., natural gas storage levels tracked weekly by the Energy Information Administration have reached all-time records for the season, at levels nearly 800 billion cubic feet, or nearly 50 per cent, higher than the five-year average. Complicating matters, some of that stored gas needs to be occasionally cycled out, adding supply to the market.
New LNG terminals, in the U.S. and Canada, may help strip away excess supply, as could fuel switching. It's now cheap enough for gas to be an attractive alternative to coal for electrical generation, for example. But the fast rise in production is far outstripping any new use for gas. The five-billion cubic foot growth in the U.S. last year, for example, is enough to produce 35,000 megawatts of electricity. That's fully half of the total produced by all of California's 1,008 power plants in 2009.