Eric Marsh, executive vice-president at Encana Corp., (ECA-T19.041.357.63%) told an investor conference in New York last week that the Calgary-based gas giant plans to steer its multibillion-dollar capital spending program for 2012 toward oil and natural-gas-liquids drilling, and away from the 'dry' gas deposits that are usually the staple of the sector. With natural gas prices mired below $3 (U.S.) per million British thermal units : the first time in a decade that gas has been this cheap in the winter heating season – and with bloated inventories and unseasonably warm weather pointing to little relief in sight, drilling for gas is a money-losing proposition.
How much farther will natural gas fall? 'At the end of the day, we invest the majority of our capital in the highest-return type projects,' Mr. Marsh said. 'We really think that the full cycle, from land acquisition through complete development, of most gas assets in North America, [break-even] is really a $4.50 to $5 gas price. When you start to get down into these $3 gas prices that we're in today, you’re challenged to put capital on those dry gas assets.'
Encana's shift away from gas may reflect the burgeoning norm in 2012. The North American industry faces the prospect of losing billions of dollars just to replace the natural depletion of existing wells and maintain production at 2011 levels: and, increasingly, producers look unwilling to do it. And while many experts think the oversupplied market could keep prices depressed for much of this year, they say this growing reluctance to invest in gas production is bound to eventually take a big bite out of supplies, and finally turn prices around.
'It's just inevitable. The multibillion-dollar question is, when,' said Peter Tertzakian, chief energy economist at ARC Financial Corp. in Calgary. 'The price is too low to entice anyone to drill for gas, when there are more lucrative oil wells to be found. The fact we’ve had this warm [start to] winter, and critically low gas prices, just accelerates this migration.'
Still, experts say, any meaningful price recovery may not happen in 2012. After all, for more than a year many people have been saying that low prices were going to slow exploration and production, and boost prices. Yet prices are even lower now than they were at the start of 2011. 'Everybody has gotten this wrong,' said Arthur Berman, a Texas based energy analyst who is one of the most vocal doubters of the sustainability of the shale production bonanza. 'The producers' behaviour has been puzzling to everyone. They have been very slow to respond to prices.'
One factor is that as producers have shifted their focus toward liquids heavy gas properties, they have continued to unlock dry gas in the process and they have been able to use the ample cash generated by liquids production to justify bringing otherwise uneconomic gas on stream. In Encana's liquids rich Deep Basin play in Alberta and British Columbia, for instance, the company can produce natural gas for '$2 or less,' Mr. Marsh said.
Hedging programs, under which producers agree to sell future production at fixed prices, have also helped sustain gas production. While Mr. Tertzakian and others believe this effect is fading as old, richer hedging contracts expire and producers are forced to accept lower prices (the Nymex natural gas futures contract for delivery one year from now is priced at a mere $3.67), shrewder hedgers have still been able to lock in comfortable prices for 2012. (Encana has hedged more than half its expected 2012 production at an average price of $5.80.)