Many Analysts Predict That Canada’s Conventional Natural Gas Production has Reached its Peak

By: Lance Mortlock

Unconventional resources (unconventionals) are quickly appearing on the radar of global players looking to replace reserves  s conventional gas continues on a steady decline. But in order to maintain market share, Canada’s unconventional gas industry must look beyond the US and seek global customers for growth.

Many analysts predict that Canada’s conventional natural gas production has reached its peak, and by 2020, analysts expect significant growth in unconventional gas production to account for 52% of natural gas production. While the future of  unconventionals looks promising, companies looking to invest and develop unconventional gas reserves in Canada and North  America will need to address a number of challenges to be successful.

Canada’s unconventionals industry, in particular, is rife with a host of challenges, including the timing of new pipeline facilities and infrastructure, uncertainty about power stations converting en masse from coal to gas, uncertainty over gas prices, cost escalation and questions about the industry’s ability to solve environmental challenges. Until the US Environmental Protection Agency releases their assessment of the environmental effects of shale gas in 2012, we may see provinces follow in the footsteps of Quebec and demand strategic environmental reviews before allowing development. Canada’s Pacific coast is  facing a similar set of challenges in addition to the lack of infrastructure in northeast B.C. to handle growth in shale gas production beyond the next few years.

The primary challenge facing the oil and gas industry, however, is overproduction and associated inventory levels. Although  Canada is currently the largest exporter of natural gas to the US (with an approximately 87% share of US imports of gas, supplying 14% of demand), considerable shale gas reserves in the US are expected to slow gas exports from Canada as supply and inventory levels reach their peak. To date, the US has been leading the way in unconventional gas development,  and, as they begin to export their own shale gas, Canadian companies will need to look for alternative export opportunities.

The US Energy Information Agency forecasts that by 2035, only 1% of natural gas in the US will come from foreign import.  lthough there is potential for the Utica Shale formation northeast of Montreal to create huge economic growth in Quebec, it will also change the flow of gas in Canada and may hinder exports from the Western Canadian Sedimentary Basin.

With these anticipated shifts on the horizon, Canadian oil and gas companies need to look for new long-term customers who  hold a long-term view of the unconventional natural gas sector in markets like Asia, where demand is rising. Canada is also  currently seeing an interest from companies that hold a long-term view of the unconventional natural gas sector, including  international oil companies, national oil companies and independents. The transportability of liquid natural gas (LNG) means new opportunities for foreign export to these Asian markets, and according to IHS CERA, LNG is expected to increase by 50%  by 2020. However, the medium and long-term effects of LNG and shale gas on Western Canada’s unconventional gas  investment competitiveness is still unclear. With reduced demand from the US and thriving eastern markets, including Utica Shale in Quebec and the 2000-mile Great Lakes gas transmission pipeline from Emerson, Manitoba, to St. Clair, Ontario, servicing Minnesota, Wisconsin and Michigan, Western Canada needs to be on the lookout for new customers. LNG  exportation and, more specifically, Kitimat may determine the future prosperity of Canada’s oil and gas industry.

With these new challenges top of mind in Canada, companies are responding to recent gas trends in one of four ways: investing, consolidating, shifting portfolios and cutting investments. In North America alone, industry investment is exceeding US$25 billion a year. Companies are managing ongoing uncertainty by sharing risk and costs with outside oil and gas  conomies through joint ventures and partnerships. Encana’s recent deal with state-owned CNPC to develop reserves in  Canada is one example of investment that will bring industry know-how back to China and enable the country to exploit their own large reserves. Encana also strengthened industry ties in a joint venture with PetroChina with the sale of 50% interest in Cutbank Ridge business assets for CDN$5.4 billion.

Companies also need to drive for efficiency and look for opportunities to cut costs using lean drilling and completion, lowering service costs such as labour, working with government on royalty structures and sharing processing facilities with other  operators.

There could also be opportunities to renegotiate transmission- and gas-processing costs and economies of scale through  shared infrastructure ownership and control. Companies can expect mergers and acquisitions and consolidation in the junior  gas sector to continue as some companies struggle to remain profitable. More value-chain integration between mid-stream  and downstream companies is also likely to help lower intermediary costs and provide market flexibility for price. This is  especially prevalent in cases in which companies are gas focused and have limited interests in oil. This may be particularly prominent in Western Canada — where high concentration of production is not met by the same degree of market access.

Overall, it is important to recognize that investment activity will be uneven across North America, depending on supply,  demand, infrastructure and the current socio-economic environment. As market dynamics continue to evolve, Canadian  companies must adapt accordingly to maintain their share of the market. Staying competitive with US companies in the gas  space will be an ongoing challenge for Canadian companies as new plays compete for large markets. With so much potential in Canada, companies need to think about where the demand will come from.

Lance Mortlock is a senior manager in Ernst & Young’s Oil & Gas practice in Canada. As leader of the firm’s oil and gas thought leadership centre in Calgary, Lance focuses on global energy industry trends and market dynamics.