The Set-Up: In February 2014 I wrote a story on how the US arm of brokerage Raymond James saw a lot of negatives for Canadian natural gas. Longer term that could be true but in this article OGIB guest writer Shaun Polczer-who was formerly an energy writer at the Calgary Herald and Petroleum Economist magazine-takes a look at Canadian natgas for a more bullish reason.
Getting ready for a natural gas rebound
It's true that Canadian natural gas exports to the US have been falling for more than 10 years.
From a peak of more than 10 billion cubic feet per day in 2001, exports to the US were a little more than 8 bcf/d in 2012, according to the Energy Information Administration (NYSEMKT:EIA), a drop of 20 per cent in less than a decade.
And it's also true that long-term exports are likely to free fall as prolific US shale fields like the Marcellus and Utica supplant traditional Canadian markets in the high-consuming northeast.
But this shouldn't be misconstrued as the end of Canadian gas. There are plenty of reasons to suggest that producers north of the 49th parallel could be in good stead for the next 24-36 months after the coldest North American winter in a dozen years.
Lower 48 storage levels are the lowest in a decade, at less than 1 trillion cubic feet heading into summer. Producers on both sides of the border will have to inject 3 trillion cubic feet by next fall to rebuild a comfortable cushion - something that's never been done.
Canadian storage levels are also essentially depleted, meaning that AECO gas from Alberta could actually trade above Henry Hub for the first time in memory. Bentek Energy's Jack Weixel sees strong markets for Canadian producers in Dawn, Michigan, and Chicago as storage is refilled.
That's prompted Duncan Robertson with Calgary-based SBM Consultants to conclude that the gas market actually turned in April of last year. SBM doesn't call prices, but rather, broader trends. And after five years in the gutter, the signal for gas has finally turned green.
"We're bullish," he said in an interview. "Storage is essentially empty. We think now is the time to be investing in gas."
But refilling storage should only be a temporary boost, lasting until the buildout of pipelines from Pennsylvania and Ohio. The real reason to be optimistic for the longer term is in the Pacific Northwest and drought ravaged California.
Traditionally, the majority of Canadian gas has flowed west to east from Alberta on the NOVA pipeline, an inter-provincial network that once accounted for a staggering 20 per cent of all the gas produced on the continent.
Because of the mountains, the north-south route leading into Washington state and Northern California was always considered a less desirable route than NOVA for capturing premium pricing - for the simple reason that it's geographically isolated from major markets.
But what was once a competitive disadvantage has now turned into a major opportunity.
Gas demand in the Pacific-Northwest is poised to jump before the end of the decade, a combination of electrical power growth and rising consumer and industrial use, but mainly due to LNG exports. On March 24, the US Department of Energy approved an application from Calgary-based Verasen to export 1.5 bcf/d from its proposed Jordan Cove LNG plant in Oregon. Originally designed to import gas from offshore, it has been reconfigured to export to Asia.
A second application is pending for another terminal up the coast, also in Oregon. Given that the northwest has no indigenous gas supply, it will either come from Canada or via Kinder Morgan's Ruby pipeline from Wyoming. Although Canadian gas competes head on with Ruby, Warren Waite, Bentek's senior energy analyst, notes that 60% of the gas presently comes from Canada.
Longer term, energy consultants ICF International predicts an additional 2,500 MW of gas-turbine capacity will be needed by 2025 to support wind generation in the Northwest, and that nearly six per cent of the region's total natural gas demand will be for that purpose, especially in peak winter periods.
That should provide a boost for northern British Columbia Montney producers until Canadian LNG exports come onstream after 2016. This is one of the reasons Canadian Natural Resources dropped $3.1 billion for Devon Canada's conventional gas assets, the majority of which are concentrated in the northern BC.
But the real story is further south, where California is in the midst of one of its worst droughts with water levels at hydroelectric stations falling to half of normal levels. After the closure of the San Onofre nuclear plant near San Diego - called Dolly Parton by the locals - the state has been relying on hydro to make up the gap.
The problem is, hydro capacity is half what it was last year and a third of what it was in 2011. If there's an El Niño this summer, experts are already warning of brown outs and extreme power shortages similar to 2004.
Little wonder, power producers are switching to gas because it's more reliable. According to Picton Mahoney Asset Management, utilities in California could see an uptick of 700-800 million cubic feet per day from fuel switching alone, notwithstanding summer cooling demand in the event of a hot summer.
In the northern part of the state, that gas comes from Alberta, via TransCanada's Foothills pipeline feeding off the big NOVA pipeline and flowing through Redwood Pass.
Bentek's Waite said drought conditions generally worsen further to the south, and the real question is how much Canadian gas will be diverted east to refill storage. It's possible that exports to California could actually dip, setting up a supply crunch in the event of a hot, dry summer. "There's definitely a need for it (Canadian gas). There's a 50/50 chance of El Niño - that could change things but it's a tough call at this point."
At some point, more pipeline capacity from the Montney and other Canadian producing regions are needed to satisfy LNG demand in addition to any incremental additions from fuel switching, according to Housley Carr with RBN Energy consultants. That will largely be determined by price, keeping in mind that higher prices will stem demand growth.
What it means
The bottom line is that Canadian gas is going to be in demand this summer, regardless of whether it flows east or west.
According to GMP Securities, a handful of Canadian producers stand to benefit immediately, even as BC gets ready for large scale LNG exports. Keep in mind that producers on this side of the border need to demonstrate 25 years of reserves before the National Energy Board will grant export licenses. That's in addition to any incremental demand from the US.
In a recent research report, GMP likes Painted Pony (PPY-TSX) and another handful of producers that hadn't previously benefited from BC royalty changes announced in March - including Artek (RTK-TSX), ARC Resources, Crew Energy (CR-TSX) and Crocotta (CTA-TSX). Northern Montney producers in the Umbach area, such as Storm (SRX-TSX), Carmel Bay (private), Paramount (POU-TSX) and Chinook (CKE-TSX) will all benefit.
Toss in the usual cast and crew from the WCSB in Alberta and Saskatchewan - the Encanas,(ECA-NYSE/TSX) Talismans (TLM-NYSE/TSX) and PennWests (PWE-NYSE; PWT-TSX) of the world, in addition to the aforementioned CNRL, and we have the makings of a natural gas party.
It's also likely to lead to a new round of consolidation and mergers among smaller juniors who have had a hard time raising capital. The small fish will be looking to gain scale, while the big fish will keep getting bigger.
With so many companies to choose from, it's a licence to drill, baby, drill.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The Oil and Gas Investments Bulletin is a team of writers. This article was written by Keith Schaefer, Editor. We did not receive compensation for this article, and we have no business relationship with any company whose stock is mentioned in this article. The author of this article has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.