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Providing coverage of Alaska and northern Canada's oil and gas industry
January 2008

Vol. 13, No. 3 Week of January 20, 2008

Gas price jumps give hope a chance

Nymex, Alberta hub both post gains in natural gas contracts, but volatility and conflicting weather reports put gas sector on edge

Gary Park

For Petroleum News

All the North American natural gas sector can rely on these days is hope, which makes the last few weeks a welcome change from the unrelenting gloom of the last 18 months.

On the New York Mercantile Exchange gas futures contracts for February delivery edged above $8 per million British thermal units in early January trading and nudged $8.20, about 20 percent higher than a year ago, with all contracts through the summer trading at more than $8.

In Canada, the benchmark AECO hub in Alberta is currently holding steady at about C$7 per thousand cubic feet, considered by most producers to be only a break-even level, but still an improvement from the C$6.20 for January and February contracts (less than half the record-breaking highs of two years ago), where it was stuck for a long period.

This winter could see change

Investment dealer Peters & Co. said the winter could see gas break out of its long-term holding pattern.

It predicts that the stocks of junior producers such as Cordero Energy, which lost half its value last summer, and Iteration Energy, which has been idling since the fall, could be among those to benefit if the higher prices are sustained.

However, Peters said the gas market “remains complex as the driving forces of seasonal cycles are now accompanied by global influences and a sustaining of the run-up in prices will be key to restoring investor confidence in the sector.”

And there’s a long way to go for the 450-odd Canadian juniors, who face a tough choice this winter of living in hopes of better times or selling before debts reach unmanageable levels and growth rates slow even more.

Shares of typical junior exploration and production companies fell an average 32 percent from July through November last year, with 70 percent of those companies posting red numbers in the third quarter, largely because 70 percent of their production is gas.

Some improvement in costs

There has been some improvement on the cost front, with drillers and service companies trimming their rates. Precision Drilling Trust, Canada’s largest contractor, estimates the average rig cost is now about C$17,000 per day, compared with C$19,500 a year ago, but 13 percent higher than the average in fall 2004.

Even if gas prices reach a sufficient level to justify a return to drilling, much of the damage has already been done.

E&P companies were simply unable or unwilling to raise capital for 2008 during the bleakest period in recent industry memory as the upstream sector grappled with low gas prices, high operating costs, the uncertain impact of higher Alberta royalties in 2009 and a malaise in the trust sector.

Traditional investors have given a cold shoulder to conventional explorers, who struggle to put any gloss on their pitch.

One of the few positive signs is the possible return of conventional juniors to the mergers and acquisitions market. Having lost out to income trusts for several years, they now have a more level playing field.

One of the surprises occurred in November when electricity retailer Direct Energy offered C$113 million cash for little-known Rockyview Energy, which produces 2,700 barrels of oil equivalent per day, 97 percent of its natural gas, has proven plus probable reserves of 42.3 billion cubic feet equivalent and 100,000 undeveloped acres.

Direct Energy has hinted that may not be an isolated bid, describing itself as a “new player” after long being ignored by bankers when companies hung out for-sale signs.

Gas sector under pressure

The betting remains strong that the gas sector remains under pressure to consolidate, seeking the economies of scale and diversification needed to grow.

Otherwise, recovery on the gas side depends on a winter deepfreeze and a hot summer coinciding with a production decline as a result of drilling cutbacks.

In Canada, the long-range forecast by Environment Canada does little to build those hopes, with Toronto running 16 degrees higher than normal and Calgary 18 degrees above the seasonal average on early January — bad news in Canada’s largest domestic markets.

In the United States, AccuWeather is among forecasters who agree winter temperatures will be above normal, especially in the December-February period, attributing the predictions to La Nina conditions.

As a sign of the forecasting uncertainty, however, Massachusetts-based WSI suggested the East could see several weeks of cold weather, with the Pacific Northwest, northern Rockies and northern Great Plains expected to be cooler than the average of recent years.

U.S. inventories above average

In the United States, the Energy Information Administration reported that natural gas in storage dropped by 171 billion cubic feet to 2.75 trillion cubic feet in the second week of January, but inventories in the Lower 48 remain about 4.6 percent above the five-year average for the time of year.

Such variations have generated widely diverging opinions on gas production trends for 2008 as analysts disagree on whether prices in the $7 per million Btu range would stimulate production growth.

Oppenheimer analyst Fadel Ghiet expects the 4 percent growth last year in unconventional plays, notably the Barnett Shale of North Texas, will continue, given that producers can make solid profits at $7, especially as drilling efficiency serves as a counter-weight to rising service costs.

He also said producers prefer to retain asset holdings in regions of lower geopolitical risk, such as the U.S. and Canada.

John Gerdes, head of The Gerdes Group, takes a contrary view, arguing that $7 prices won’t support even the current pace of drilling — a view he said has become entrenched in Canada, where the economics of unconventional plays do not support a production uptick.

Ghiet is counting on unconventional Rockies production leading growth in 2008, although he shares Gerdes’ view that a shortage of takeaway infrastructure is a concern.






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