TD sounds alarm for Alberta's natural gas industry

Alberta's natural gas industry faces risksthat "are significant and growing," according to areport released Monday by TD Economics.

The report by Derek Burleton, TD's director of economic analysis, cites competition from British Columbia's increasing gas production and the potential loss of the U.S. as an export customer.

Natural gas exploration and development is a cornerstone of Alberta's economy,generating $35 billion to $40 billion or one-tenth of the provincial economy in 2008 and directly employing up to 140,000 people.

In 2009, the industryhas been ravagedas prices for the heating fuel have fallen to $3 US from $8per million British Thermal Units. Natural gas closed Monday in New York down26 cents at$3.73.

Prices have fallen to seven-year lows not only because of a combination of last year's mild winter and falling demand because of the recession, but also because ofincreasing production from shale formations.

Domestic production in the U.S., which in the past has relied on Alberta for up to one-seventh of its consumption, has boomed since 2004, as new technology opens up new areas. The technology fractures and props open formations that were previously inaccessible.

In June, the Colorado School of Mines came out with a report showing shale gas production has boosted American supplies by 35 per cent, its largest jump in the 44 years it has been collecting data.

"There has been some speculation that the U.S. might one day join the small list of countries no longer relying on net imports of natural gas," Burleton said in the commentary.

At the same time, competition for the American market is heating up.Shale gas formations are opening up in Quebec, Atlantic Canada, and Saskatchewan, but especially in British Columbia's Horn River and MontneyBasins. Companies have invested$4 billion for drilling rights in B.C. since 2006 and are now producing one trillion cubic feet a year, making that province Canada's second largest producer.

Some win in the shift to shale

The shift to shale is also favouring the stocks of some companies that provide production services that use that new technology. The financial services firm UBS tracked share prices and said in a report released Monday that over the past month,Calfrac, Trican and BJ Services have outperformed theirdrilling peers by as much as33 per cent.While it predicted several quarters of weak earnings yet,itexpected shale service companies to do better than conventional drillers.

Still, shale gas may end up overrated.What's uncertainare its decline rates, the rates at which wells are exhausted.Limited evidence shows these to be higher than conventional gas wells.There are also environmental concerns about water contamination, which could discourage investment.

Some companies have blamed the Alberta government increase in royalties for adding to the problem. Burleton's analysis found,depending on market price and production levels, natural gas royalties were raised to 15 to 50 per cent from 15 to 35 per cent by the changes, which took effect this year.

By comparison, natural gas royalties in B.C.ranged from nine to 27 per cent, depending on price. Despite the complaints, at low natural gas prices, Alberta royalties remained competitive, Burleton said.

What's not debated in Alberta is that companies have laid off workers, drilling rates have plummeted, and firms have "shut in" production by turning off wells.

'...natural gas will never return to the same prominent place it occupied in the Alberta economy onlyfive to 10 years ago.' Derek Burleton, TD Economics

"It appears that Alberta's economy continues to contract as most other regional economies in the country show signs of renewed life," said Burleton.

"The potential for an accelerated long-term decline of an industry that does so much of the heavy lifting in the Alberta economy is arguably the number one risk facing the province's standard of living," he wrote.

Burleton concluded that Alberta's natural gas industry will never return to asprominent a position in the Alberta economy as it enjoyed only five to 10 years ago. Still, he refused to count out Alberta natural gas. Future markets would suggest prices will return to $5 or $6per million British Thermal Units by March of next year.That would help some, but not all producers, according to the Ziff Energy Group.

What is certain, said Burleton, is the need for the Alberta government to rein in spending.Already, falling royalties have contributed to a deficit expected to hit almost $7 billion this year.

The "rapid spending years of the past half decade when annual outlays rose at a double-digit rate will need to be relegated to Alberta's history books," he said. "Parsimony in non-priority areas will need to be the watchword even once surpluses re-emerge. On the plus side, the growth-related pressures that drove much of the robust spending increases earlier this decade appear unlikely to return over the foreseeable future."