After three years of deeply depressed natural gas prices and facing another to come, Canada's biggest natural gas producer is losing its stomach for the commodity.
Eric Marsh, executive vice-president at Encana Corp., told an investor conference in New York last week that the Calgary-based gas giant plans to steer its multibillion-dollar capital spending program for 2012 toward oil and natural-gas-liquids drilling, and away from the "dry" gas deposits that are usually the staple of the sector. With natural gas prices mired below $3 (U.S.) per million British thermal units – the first time in a decade that gas has been this cheap in the winter heating season – and with bloated inventories and unseasonably warm weather pointing to little relief in sight, drilling for gas is a money-losing proposition.
"At the end of the day, we invest the majority of our capital in the highest-return type projects," Mr. Marsh said. "We really think that the full cycle – from land acquisition through complete development – of most gas assets in North America, [break-even]is really a $4.50 to $5 gas price.… When you start to get down into these $3 gas prices that we're in today, you're challenged to put capital on those dry gas assets."
Encana's shift away from gas may reflect the burgeoning norm in 2012. The North American industry faces the prospect of losing billions of dollars just to replace the natural depletion of existing wells and maintain production at 2011 levels – and, increasingly, producers look unwilling to do it. And while many experts think the oversupplied market could keep prices depressed for much of this year, they say this growing reluctance to invest in gas production is bound to eventually take a big bite out of supplies, and finally turn prices around.
"It's just inevitable. The multibillion-dollar question is, when," said Peter Tertzakian, chief energy economist at ARC Financial Corp. in Calgary. "The price is too low to entice anyone to drill for gas, when there are more lucrative oil wells to be found. The fact we've had this warm [start to] winter, and critically low gas prices, just accelerates this migration."
Still, experts say, any meaningful price recovery may not happen in 2012. After all, for more than a year many people have been saying that low prices were going to slow exploration and production, and boost prices – yet prices are even lower now than they were at the start of 2011.
"Everybody has gotten this wrong," said Arthur Berman, a Texas-based energy analyst who is one of the most vocal doubters of the sustainability of the shale production bonanza. "The producers' behaviour has been puzzling to everyone. They have been very slow to respond to prices."
One factor is that as producers have shifted their focus toward liquids-heavy gas properties, they have continued to unlock dry gas in the process – and they have been able to use the ample cash generated by liquids production to justify bringing otherwise uneconomic gas on stream. In Encana's liquids-rich Deep Basin play in Alberta and British Columbia, for instance, the company can produce natural gas for "$2 or less," Mr. Marsh said.
Hedging programs – under which producers agree to sell future production at fixed prices – have also helped sustain gas production. While Mr. Tertzakian and others believe this effect is fading as old, richer hedging contracts expire and producers are forced to accept lower prices (the Nymex natural gas futures contract for delivery one year from now is priced at a mere $3.67), shrewder hedgers have still been able to lock in comfortable prices for 2012. (Encana has hedged more than half its expected 2012 production at an average price of $5.80.)
Market watchers also noted that the transportation infrastructure hasn't been able to keep up with the rapid expansion of shale-gas production in the past couple of years – meaning that even as some producers have curtailed their drilling, there has been a backlog of previously drilled wells to be tied into the infrastructure. This helped sustain production levels last year, and should continue to do so well into this year.
"While we do not expect producers to be immune to lower prices, continued strong production growth despite lower prices and a meaningful backlog of wells in key growth areas like the Marcellus Shale suggest this period of lower prices will likely need to be sustained for longer," wrote Goldman Sachs analyst David Greely in a research note last week, when he slashed his 2012 price projection to $3.10 from $3.70.
"There's enough extra in the system that prices are going to be low at least through 2012," Mr. Berman said. "In fact, I wouldn't be surprised if prices got even lower. We could easily get into the $2 range.
"But the price is going to go up eventually. It has to," he argued.
"The longer term looks very, very favourable for natural gas," Encana's Mr. March asserted. "The challenge will be these next two to three years."
The capital gap
Research by energy economist Peter Tertzakian shows just how economically strained natural gas exploration and development has become in the past few years, as the boom in high-tech shale-gas drilling has both massively swelled North American production rates and greatly increased costs.
He noted that shale wells not only cost "three to four times" as much to develop as conventional gas wells, their rate of depletion – the amount production declines over time, a natural phenomenon with all wells – is much higher. As a result, the average annual depletion rate across the industry has risen from about 23 per cent five years ago to more than 32 per cent now.
That, combined with the 20-per-cent surge in North American gas production in the past five years, (which makes for more and more depletions to replace each year), has meant it now costs the industry about $22-billion each quarter just to replace the annual depletions and maintain current volume levels. Yet those producers are seeing only about $12-billion a quarter in cash flow, he said.
"The resulting capital gap is now on the order of $10-billion a quarter, or a phenomenal $40-billion a year," he said.