Running on empty
By Andrew Nikiforuk

Canadian Business
10 July 2000

When Canada's natural gas reserves hit the crisis point, who will be left out in the cold?

When you start cursing the size of your natural gas bill this winter, you should think first of Rob Woronuk. He's a sharp, 59-year-old Calgary mathematician and independent gas analyst, and he'll tell you that all the numbers on natural gas reserves pointed toward troubling shortages and higher prices more than half a dozen years ago. No alarm bells rang out then because, well, no one really is responsible for keeping an eye on natural gas reserves in Canada. "Consumers thought prices were nice and low," he says, "but nobody told them that they were living on borrowed time."

If you live in Central Canada and narrowly avoid natural gas rationing during a brutal cold snap this winter, you should thank Jim Gray. He's the chairman of Canadian Hunter Exploration Ltd., one of Calgary's Blue-Eyed Sheiks, and a whistle blower on the looming natural gas crunch. In a recent speech, he boldly proclaimed that North America is just about to hit the wall on supply and demand for natural gas; he decided to come forward because he thinks consumers ought to know the truth. "The worst thing is for people to be surprised," says Gray, whose speech put it this way: "Houston, we have a problem."

And if you're wondering how a country so dependent on energy for heating and transportation could abruptly find itself in the midst of a natural gas shortage (and the pessimists say it could last a couple of years), then remember Mike Sawyer's name. As the executive director of the Citizen's Oil and Gas Council, this low-paid activist has repeatedly scolded Ottawa's National Energy Board (NEB) over the last decade for market-based policies that have short-changed the public interest. "The US treats energy as strategic commodity," says Sawyer, a Calgary-based researcher. "But here in Canada we piss away our resources and have no intelligent government policy on energy. The NEB didn't even predict this shortfall."

That's just a taste of what one pipeline analyst ruefully calls "the mess"-and what you'll be reading about this fall in gigajoules. Not only is Canada's looming natural gas crisis a sorry affair; it's a fully predictable one with widespread implications. Tight gas supplies not only mean higher heating bills; they also mean pricier electricity, inflationary pressure and fuming voters. Some industrial sectors such as pulp and paper are already switching back to fuel oil due to climbing gas prices. "There is no way out of this in the short term," notes Tom Christie, an investment adviser with BMO Nesbitt Burns. "If it's a cold winter, some people in the oil and gas industry are even afraid Ottawa might re-regulate natural gas."

The growing strategic importance of natural gas hasn't escaped the attention of the multinationals. Three of Canada's biggest producers-Shell Canada Ltd., Petro-Canada and BP Amoco PLC-started dumping their oil assets in 1999 to concentrate on oil sands production and gas holdings. Many of these same players are now participating in a full- scale gas rush into the Northwest Territories and the Mackenzie Delta, where five different pipeline proposals are jockeying for favor.

But rising gas prices in a deregulated market with declining reserves will make the most headlines. Three years ago, the spot price for gas sat at $1.12 per thousand cubic feet. Now it's skyrocketed to $5.80. For the first time in Gray's long and successful career, he predicts "prices will be higher this summer than they were last winter." In addition, summer storage levels are at all-time lows in some areas. "This mess raises significant public policy questions," says one pipeline analyst. "And the key one is this: Is there a will to make public policy on natural gas in this country?"

The crisis, of course, has been building for years and owes much to North America's booming economy and the popularity of natural gas for electrical generation. Unlike coal-fired plants and nuclear power stations, a gas-fired generator doesn't take much time and capital to light up a region. Nor does it pollute the air or saddle future generations with horrendous environmental burdens. As a result, the Canadian Energy Research Institute estimates that gas demand for electricity generation could almost triple over the next decade.

Similar developments in the US, plus declining domestic supplies, have steadily ratcheted up demand for Canadian gas. Since 1986, US imports of Canadian gas have increased fivefold. In fact, Canada now exports more than half of all its gas production (that's more than $11 billion worth) south of the border. Within the next five years, the US Energy Information Administration predicts that Canada's share of the US gas market will climb to 18.4% from 14%. "A third of all of the world's gas consumption takes place in North America," notes Gray. "We are dealing with a giant and when it starts to falter a little bit then you are dealing with something that has enormous consequences and can't be turned around with a single strategy."

And that's where the problem comes in, because many experts don't believe Canadians can find enough gas to satisfy US demands, let alone fill existing pipelines. Take the multibillion-dollar Alliance megaproject that will ship gas from northern BC to Chicago markets this December. "It will provide surplus capacity to move gas to the US we don't have," notes Woronuk. "It's unfortunate." As a result, Alliance may have to hijack gas from TransCanada PipeLine's lines to fulfill its commitments.

It's not that the Western Canada Sedimentary Basin has died or gone dry. It's just that half of its reserves, the shallowest and easiest to exploit, have already been drained to warm North American homes. And the remaining reserves, including some in national parks or under Calgary's suburbs, are either off limits, terribly sour or very difficult to tap in economical quantities. Despite a record drilling of 6,300 gas wells in 1999, overall gas production isn't going anywhere in Alberta. "The myth is that we have lots of gas and lots of activity to get it, but we don't have lots," says Woronuk. "The limits of the basin are being realized."

These limits can be read in any number of ways. Industry, for example, is at the moment replacing only about 70% of what we are consuming back into the system. Since the 1960s, the average size of gas pools has noticeably shrunk from 25 billion cubic feet to 1.6 billion cubic feet. Many wells today yield little more than half a billion cubic feet. "The size of a decent well just keeps going down," notes Christie. "I listen to lots of guys in the industry bragging about new wells, but they are just dog and pony shows. Until we go to the frontier, no really significant reserves will be discovered."

But therein lies another problem. Canada's frontier gas reserves just can't be developed quickly. It takes big bucks and long lead times to pump gas out of the eastern seaboard or northern barrens. In fact, Gray suspects that it may take as long as seven to 10 years and as much as $10 billion to put northern gas in southbound pipelines. "You just can't add water and shake," adds Gray. "We have become dangerously complacent regarding our natural gas supplies on this continent."

The shortage has also been compounded by natural gas deregulation in the late 1980s-and the NEB's wonky New Age philosophy on gas supplies. In the Old Economy, companies found the gas first, kept accurate tabs on reserves and then identified markets based on shrewd cost projections. But since deregulation, the NEB has operated on the belief that if you build a pipeline, gas will suddenly fill it. "It's self-serving in times of ample supply, but as reserves decline we are screwed," notes Sawyer. "By next winter, gas prices could be 300 to 400 times higher. Is that regulation in the public interest?"

And gas prices are indeed going up across the board. According to Union Gas Ltd., one of Ontario's major utilities, the average residential customer has already seen a 12% increase this year. Enbridge Consumers Gas just tacked on $10.50 to its customers' monthly bills and Atco Gas added $4 more per month. Unlike easterners, who get their gas from a mix of short- and long-term contracts from a variety of sources, Albertans are already feeling the the crunch every time the spot price rises.

Nor do top analysts, such as Martin Molyneaux at Calgary's FirstEnergy Capital Corp., see any relief in sight. "We believe we are seeing a long-term shift in how North America looks at natural gas," says Molyneaux. "There have been a whole series of miscues, and we have overestimated supply and underestimated demand. All at a time when we have $30-plus oil prices." He adds: "Politicians in North America just don't have a clear energy policy."

The NEB has truly been asleep at the wheel. According to a high-minded study published last year, the regulator predicted that there would be no declines in gas production until 2010-and that prices would remain 50% below current levels. "They missed this current shortfall entirely," notes Woronuk. The NEB's faulty economic model, he explains, overestimated what was in the ground and based its projections on sources of gas that are not yet available.

In fact, Woronuk is the only Cassandra who has consistently predicted a supply-demand crisis. In addition to running his own company, Gas Energy Strategies Inc., he is also a member of the Canadian Gas Potential Committee (CGPC), a volunteer group of 35 geologists and industry types that recognized as early as 1991 that no federal agency was minding the natural gas pool. "The NEB has done nothing in terms of potential reserves," notes Woronuk. "Yet it's important for Canada to have an accurate assessment of what we have. You and I own the resource, yet Canada can't even be bothered to husband it."

Canadian Business couldn't reach NEB chairman Kenneth Vollman to ask questions on husbandry and price. Instead, the board had its chief economist, Glenn Booth, give us a call. For starters, he said the NEB doesn't comment on other people's forecasts-and is not in the business of projecting short-term prices. "Our responsibility is to make sure there is gas for Canadians in the future, and our view is that there will be," he says. How much it might cost is another issue. "We are concerned that prices have gone up so quickly so fast, and we are closely monitoring it," adds Booth, who says that some market indicators suggest high prices won't last for long.

That's the view being taken south of the border. John Cochener, an energy analyst at the Gas Technology Institute in Arlington, Va., agrees that the market is tight but points out that the US has reserves it can tap into quickly in its Rocky Mountain region or the Gulf of Mexico. He argues that the current shortfall is just the lag effect of low energy prices and a North American drilling slump in 1998. "Will we see shortages and factories being shut down? I don't think it will be that bad unless we have the worst winter and the hottest summer of the past century."

The CGPC now reckons that "initiatives to address the forthcoming supply issues should probably have commenced yesterday." There is some optimism that higher prices will spur technological innovations and prudent mining of old reserves. Developing methods to tap into unconventional gas resources, such as coal-bed methane, might also be wise. Woronuk would also like to see more exploration in the Alberta foothills-already an expensive (try $30 million a well) and politically sensitive proposition. Tensions there between landowners and gas explorers have reached troubling heights due to the uncontrolled density of activity and inadequate regulation of sour gas emissions.

Some would like to see consumption decrease with perhaps a federal program to subsidize more efficient water heaters. Yet others argue a reasonable response to the gas crunch might also include the formulation of a national energy strategy-complete with an intelligence unit-so that key decisions and knowledge aren't always left in the hands of the marketplace and multinationals. "Managing a crisis doesn't always result in good decisions," notes Sawyer.

Of course, each and every public policy crisis also comes with investment opportunities. Companies with solid gas reserves, such as Canadian Hunter (TSE: HTR); Canadian Natural Resources Ltd. (TSE: CNQ), headed by proven manager Murray Edwards; Alberta Energy Co. (TSE: AEC); and Paramount Resources Ltd. (TSE: POU), which has strong holdings in the Northwest Territories, are obvious choices. Even though shares in these companies have almost doubled in value in the last six months (Canadian Hunter, for example, has climbed from an average of $19 last year to $33 on June 22), most analysts still consider them good buys. "Their share prices still don't reflect higher gas prices," notes Christie. He advises investors, however, to stay away from small gas companies for the simple reason that they don't have the capital to find big reserves. Broad-minded investors might also consider energy utilities, firms focusing on alternative sources such as solar and companies that do energy audits. "We are potentially entering an energy crisis going into this winter at the same time as a US presidential election," says Molyneaux. "It's going to be interesting."

At the end of the day when the furnace comes on, however, investors and consumers can count on few natural gas truths. The fuel of the future is going to cost more because demand is racing hard against supply. The Western Canada Sedimentary Basin has been a good resource but it's aged and has few easy pickings left. Last but not least the government, as usual, has been a bad shepherd and doesn't have an accurate picture of what's going on-or why. Yes, you should have bought natural gas stocks yesterday.

Copyright Canadian Business

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