Gas on the rocks

With demand down and prices tumbling, the rush to explore unconventional natural gas fields has all but ended, taking with it the hopes of royalty-hungry landowners. It's a scene that's playing out across North America -- and few are optimistic that prices will turn around soon, Shawn McCarthy writes

SHAWN MCCARTHY

From Wednesday's Globe and Mail

March 4, 2009 at 3:26 AM EST

OTTAWA — GLOBAL ENERGY REPORTER

The natural-gas-fired land boom has fizzled in Tioga County, a bucolic area of dairy farms and wooded hills in northern Pennsylvania, where the credit crunch and plunging commodity prices have taken the steam out of one of the most promising shale gas plays in North America.

Just a year ago, there was a feverish, land-rush atmosphere surrounding the Marcellus gas play as farmers were fetching as much as $2,000 (U.S.) an acre to lease right-of-way on their land to gas producers from the U.S. and Canada. Now, leasing packages fetch nary a bid and drilling is beginning to fall off, raising concerns about whether the landowners will ever see the promised royalty payments from future production.

"This is lifesaving money," local land agent Jackie Root said of the oil company investments that have flooded into her out-of-the-way corner of Pennsylvania.

Videos

00:00:00.000

Gas Symposium

Brett Harris reports the highlights from the gas symposium in Calgary

Play Video

In Alberta, the drop in oil and gas activity has grown so dire that the provincial government yesterday offered those who are drilling and producing wells a massive royalty discount in hopes of prodding more oil-patch-related

activity.

Land agent Ms. Root and her husband, Clifford, run a dairy operation in Tioga County.

The gas-related payments mean "farms don't have to be subdivided, or people won't have to take work off the farms, or they can pay back the banks," she said.

Tioga County - and other counties that sit atop the Marcellus deposit in New York, Pennsylvania and West Virginia - has benefited from the same surge in oil and natural gas prices that fuelled Alberta's oil sands boom and the gas drilling rush in northeastern British Columbia. But now slumping industrial demand and growing production from unconventional fields in the United States - including shale gas - have sent natural gas prices tumbling and inventories soaring. After touching $15 for 1,000 cubic feet in the spring of 2008, gas prices have fallen to $4.20 on the New York Mercantile Exchange, and many analysts believe they have not yet bottomed out.

The industry's retrenchment, as seen in Tioga County, is being replicated across the continent. As a result of the lower prices and the lack of credit, oil companies across North America are slashing their budgets for exploring and developing natural gas fields.

And there is little optimism that natural gas prices can return to their boom-time levels for a sustained period of time.

With the potential for relatively low-cost production growth from exciting unconventional gas plays, many analysts believe the industry faces a de facto cap on prices over the medium term. And that's bad news for Canadian producers, who face higher costs, on average, than their U.S. competitors. "It's going to be difficult to sustain higher prices," said Randy Ollenberger, an analyst with BMO Nesbitt Burns Inc., "because if you started moving into an $8 or $9 world, there's just far, far too much gas potential and supply growth potential that you can't sustain those kind of prices."

Last year, the continental U.S. saw its natural gas production grow by 10 per cent to 55 billion cubic feet a day, powered by huge production increases from shale gas plays like the Marcellus, Haynesville in Louisiana and Texas's Barnett field. In Canada, gas production actually declined by about 4 per cent or 700 million cubic feet a day to 15.7 billion cubic feet a day.

The leading indicator for gas production is the drill rig count - how many rigs are in the field at any given moment exploring for and developing new fields. "Drilling activity on both sides of the border is collapsing faster than a bank loaded with toxic debt," Mr. Ollenberger said.

In Canada, drilling activity is down 50 per cent from its peak in 2007. Companies continue to focus their spending on unconventional gas deposits in the foothills of the Rockies, and in northeastern British Columbia, where Horn River and Montney sparked a land rush similar to ones surrounding the most exciting plays in the U.S. But in the conventional explorations areas of flatland Alberta and southern Saskatchewan, drill crews are becoming more and more scarce.

In the U.S., rig activity is down 20 per cent, and will have to decline by another 20 per cent to eventually bring production in line with depressed demand, said Peter Tertzakian, economist with Calgary-based ARC Financial.

Before prices rally, the industry needs to see production fall significantly, a bottoming out of the economy and some extreme weather to underpin demand. Analysts don't see a significant rebound until the end of the year, at the earliest.

EnCana Corp., Canada's largest natural gas producer, has slashed its budget for natural gas exploration and production by $1-billion this year compared with last. Most of that decline is occurring in Canada as the company focuses on its unconventional U.S. prospects. "The capital flows to where we can get our best returns. And in the U.S., we're getting some very good returns in the big plays," said Mike Graham, president of EnCana's Canadian Foothills division. "Canada still has tremendous resources but it has to make sure it can stay competitive with the U.S."