North America’s natural gas barometer lurched in a troubling direction Feb. 15 when the continent’s second-largest producer slashed US$500 million from its 2006 upstream budget.
Raising the alarm over the soaring cost of drilling rigs and support services, and acknowledging that current price weaknesses played a role, EnCana decided it was time to “maintain capital discipline in such volatile times” and thought it would be “imprudent” to plan for growth that would exceed 2005, Chief Executive Officer Randy Eresman said.
EnCana’s announcement was accompanied by a report that service costs in the Western Canada Sedimentary basin have climbed 56 percent in the past three years, including 19 percent in 2005, and are expected to add at least 15 percent this year against a background of gas prices that have slipped to their lowest level in seven months.
EnCana’s own costs rose 18 percent in the U.S. and 14 percent in Canada last year and it projects at least 15 percent this year, although Eresman noted that some of his peers are forecasting hikes of 15 to 30 percent, reflecting EnCana’s lower costs because of its focus on resource plays.
Despite a recent cold snap in the U.S. Atlantic Seaboard, Eastern Canada and the Canadian Prairies, gas in storage is 40 percent higher than the five-year average — 600 billion cubic feet in the U.S. and 100 bcf in Canada.
Small producers are just as nervous as EnCana, with Calgary-based Kereco Energy contemplating trimming a C$95 million budget by C$10 million to C$15 million.
Gas price forecasts downThe warmer-than-usual winter has forced a drastic revision of gas price forecasts, with producers who had been counting on average prices of about C$9.75 per thousand cubic feet at the AECO hub now faced with a slide towards C$8, dangerously close to production costs of C$6.50, and close to US$7 per million British thermal units in New York trading.
However, Eresman remains upbeat about the long-term, with 2007 forward prices in the range of US$9 per million British thermal units.
He said it is “getting more and more challenging to replace the overall declines.”
Once the market regains its balance North America will “still be in a supply-shortage situation.”
For now, the cost crunch is taking its toll on EnCana and spilling over to smaller players.
The combination of costs and weather-related setbacks saw EnCana complete 4,700 wells in 2005, only 80 percent of what it had targeted.
The budget cuts include US$200 million from development programs and US$100 million from exploration, lowering upstream expenditures to US$5.7 billion-$6 billion from a forecast of US$6.6 billion-$7 billion last October.
The other US$200 million cut was actually spent in late 2005, stemming from a decision to accelerate coalbed methane wells and expand in-situ oil sands programs.
Two-thirds of the cuts will affect the Piceance basin in Colorado, one of EnCana’s highly rated but most challenging natural gas assets.
Company adding purpose-built rigsIn an effort to take greater control over its costs, EnCana plans to add about 60 purpose-built rigs this year to its North American fleet of 145. Of the new rigs, 15 are intended for Piceance.
The company has also contracted fixed prices for about 50 percent of its 2006 spending.
The revised program will trim 75 million cubic feet per day from the previous forecast of 3.42-3.56 billion cubic feet per day — still 8 percent above the 2005 volumes.
How much EnCana’s changes will spread through the rest of the gas industry is not clear, although Tristone Capital analyst Chris Theal expects widespread budget revisions and Sanford C. Bernstein analyst Ben Dell doubts the Canadian independent cut deeply enough.
Eresman is confident EnCana can hold the line on the new budget without posing any risks to what he described as a “reasonably conservative” production forecast.