Ziff: Can conventional gas stay competitive in Canada?

By OGJ editors
HOUSTON, June 12
-- Low prices for natural gas and high costs create a difficult question for the conventional gas-producing industry in Canada, says a report by Ziff Energy Group, Calgary: “Can it be competitive, even with royalty relief?”

While oil prices have doubled since early last year, gas prices remain low, the report notes. The ratio of the oil dollar-price per barrel to gas price per thousand cubic feet has historically been 8:1-10:1. With gas selling at $4.20/MMBTU (US) at Henry Hub and oil at $75/bbl, the ratio is 18:1.

While gas sells at that “huge discount” to oil, Ziff says, costs of Canadian gas producers remain high. The firm estimates the full-cycle cost of natural gas—including operating cost, royalty, drilling and completion costs, other finding and development capital costs, overhead, and the cost of capital—at about $6.30/Mcf (Can.; %5.98/Mcf in US dollars at recent exchange rates).

With the addition of 55¢/Mcf for location differences, the Canadian average new-gas cost of $6.85/Mcf is 7% higher than the North American average, Ziff says.

Reserves ‘cannibalized’
Estimating the reserve life index—reserves divided by production—of the Western Canada Sedimentary Basin (WCSB) at 8 years, the firm says Canadian gas producers must replace 20% of production and 12% of reserves each year.

“As the proven reserve base is produced into a low gas-price environment, reserves are cannibalized to sustain production levels,” Ziff says. “But with low conventional gas drilling, the reserve base shrinks, thereby decreasing financial loan amounts, which can lead to a ‘death spiral.’”

While in the US additions to reserve amounted to 1.7 times production last year, Canada replaced only one third of its production. Reserves additions from drilling were 215% of production in the US and 85% in Canada.

“Producers’ conventional gas reserve base is shrinking, and in the near future more equity or debt will be needed to fund replacing the gas produced today,” says Paul Ziff, chief executive officer, who prepared the report.

His report notes that production from unconventional reservoirs is moderating the Western Canada decline but not arresting it.

The report says a separate Ziff study projected that WCSB gas production will decline by 15% to less than 13 bcfd by 2020 despite shale and tight-gas development.

‘Mature’ basin
Calling the WCSB “mature, not dead,” the study calls for changes in business practices.

“When energy prices are high, service companies increase their service rates,” Ziff says. “When prices are low, the producers beat up the drillers and service providers.”

The report urges producers to:

• Focus on low-cost production operations “by reducing costs for drilling, finding, and operating and concurrently strengthening their gas production uptime metrics.”

• Stabilize capital spending from year to year, “investing ‘counter to the cycle,’ over-spending cash flow when costs are low to lock in low finding and development and future depreciation, depletion, and amortization (generates higher future profits), and under-spending (discipline) when costs are high.”

• Hedge to ensure predictability in cash-flow capital programs and dividend payments. “The goal is not to ‘beat the house’ or try to outsmart the market, rather to generate predictability for investors and create a sustainable spending program,” Ziff says.

• Shut in production excess to demand when gas prices are very low.

The report also calls for new relationships between producers and service providers, such as through multiyear alliances.

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