Thursday, October 22, 2009

Canadian Natural Gas Producers Have Tough Production Pricing Model
Carrie Tait, Financial Post Published: Wednesday, October 21, 2009

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Rising natural-gas prices may bring some relief to Canada's dismal export picture but the fossil fuel's economic contribution may be muted by the strong Canadian dollar and declining output, the result of energy companies pulling back production plans during the past two years.

Natural gas settled at US$5.16 per million British thermal units on the New York Mercantile Exchange yesterday, up nearly 7% on the day. The spot price for natural gas dipped below US$3 in August, a seven-year low.

"It could end up being net neutral," said Peter Tertzakian, chief energy economist at Calgary's ARC Financial Corp. "The good news is price is going up; the bad news is volume is going down."

Energy's contribution to the Canadian economy has traditionally been split 50/50 between oil and gas, Mr. Tertzakian said.

That divide, however, has been shifting in oil's favour as bitumen production and demand are climbing and natural-gas efforts have slowed.

While oil's popularity makes up for natural gas's economic shortcomings, Canada loses its diversification advantage while heavily relying on one market, the United States.

"As long as [oil] is in demand, we're OK," Mr. Tertzakian said. "But if anything serves to challenge or threaten that product, you're...more vulnerable."

Indeed, a slew of legislators and lobby groups in the United States are trying to ban oil made from Alberta's bitumen, arguing greenhouse gases emitted as it is extracted and processed are especially high. The logistics of such an idea, along with continued healthy demand from south of the border, serve as a huge hurdle to the green campaign.

However, natural-gas producers will be reluctant to resume drilling until prices show long-term stability between US$5 and US$8 per mmBtu, Mr. Tertzakian said. And even when companies decide to head back into the field, there is a lag time of about a year before new gas hits the market.

Bart Melek, BMO Capital Markets' global commodities strategist, argues Canada will immediately benefit from higher prices.

"Higher prices...mean better trade numbers for Canada," the Toronto-based number-cruncher said. "It helps the current account balance almost immediately."

"It has an fairly quick order through the trade balances.... The implications, of course, are that it is good for the economy."

Canada posted a record trade deficit in August of $2.0-billion, dragged down by slumping manufacturing exports and lower values for commodities. Although commodity prices have rebounded in recent months, many remain below their highs. Natural gas has been decidedly slow to join in on the global economic recovery story.

Canada, Mr. Melek calculates, supplies between 13% and 14% of the natural gas used in the United States. While storage inventories are roughly 14% higher than they were a year ago and about 15% above the five-year average, winter is about to take control of North America's thermostat. Cold weather means rising demand.

But at the same time, Todd Hirsch, a senior economist at ATB Financial, argues natural-gas prices are bumping up against the top end of his price forecast. On the low end, gas could dip to US$3.50 per mmBtu, he said.

"Because of the shale gas in the United States, if the price gets any higher than US$5, it is going to be a signal for them to put more of it on the market," Mr. Hirsch said. "And they can [produce it economically] for US$4."

"At US$5, they just kind of shut it in [in Alberta] because they can't produce it economically," the Calgary-based economist said. "Gas producers [in Alberta] need around $6."

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