OUTLOOK 2005: International
Canadian Outlook

Two consecutive, record-setting years deserve yet another

Encouraged by high prices and strong gas demand, Canadian producers look to achieve further gains

Robert Curran, Calgary

In the oil and gas business, rarely do events match the hyperbole that often proceeds them. But producers have done just that, following up the busiest year in Canadian history with a record-breaking performance in 2004. Optimism abounds, as producers look forward to continued strong prices and buoyant demand.

It’s been a long time in Canada since the industry was this bullish at the outset of a new year. The customary level of cautionary views seems diminished by optimism, fueled by an industry with money in its collective pocket and an energy-hungry market.

OVERVIEW
The New Year kicked off with oil prices hovering near C$60.00/bbl (US$49.05/bbl) and natural gas fetching C$7.00/Mcf (US$5.72/Mcf) on Alberta’s spot market. The high prices have carried through from last year, when producers reaped the benefits, raking in profits of about C$11 billion through three quarters.

Not surprisingly, the profits translated into some aggressive spending during 2004, boosting the outlook for capital outlays in 2005. Canadian companies exceeded their budgets by 16% over mid-year targets, according to a survey conducted by Lehman Brothers. The survey also indicates expenditures will increase a further 8.6% in 2005.

The top spender within Canadian borders this year will once again be EnCana, at US$3.1 billion, up slightly from 2004. Others with aggressive spending plans include Canadian Natural Resources Limited, at $1.8 billion (up 37%); Husky Oil, $1.5 billion (up 15%); Devon Energy, $1.2 billion (up 29%); Talisman Energy, $1.1 billion (up 1%); Imperial Oil, $965 million (no change); Burlington Resources, $900 million (up 13%); Apache, $700 million (no change), and ConocoPhillips, $550 million (down 6%).

This exploratory well exemplifies Burlington Resources Canada’s Cretaceous drilling program in the Foothills area along the Alberta-British Columbia border. (Photo courtesy of Burlington Resources.)

The bullish pricing and activity outlook also points to continued strength in share prices, building on exceptional growth in 2004. Canadian energy stocks outperformed the broader market, with growth in the Toronto Stock Exchange’s energy index reaching 29%, almost double the 15% increase in the composite index.

A strong market, increased cash flow and the ever-present search for low-cost reserve additions almost invariably lead to increased merger and acquisition activity, and a healthy ration of grist for the takeover rumor mill.

Transactions. One of the more persistent rumors continues to be that Hong Kong’s Li Ka-shing is poised to sell his stake in Husky Energy Inc. to China Petrochemical Corp. Trading volumes have increased as speculation continues, and the price for shares of Hutchison Whampoa, Li’s publicly traded company that owns a 35% stake in Husky, hit annual highs in late 2004. The deal would be a natural for both parties, given Li’s propensity to buy and sell assets, and China’s growing thirst for crude oil.

Some deals of note in the last half of 2004 include:

• Nexen’s US$2.1-billion acquisition of EnCana (U.K.) Limited, which holds assets in the North Sea, the Gulf of Mexico, and Ecuador. EnCana plans to use the proceeds to pay down debt and initiate a share buyback program.
• Canadian Natural Resources’ C$700-million (US $572.2-million) purchase of Canadian oil and gas assets from Anadarko Petroleum, which also sold another package worth $153 million (US$125 million) to an undisclosed buyer at the same time.
• Enbridge Inc.’s US$613-million acquisition of pipelines and gathering systems in the Gulf of Mexico from Royal Dutch/ Shell.
• Bonavista Energy Trust’s C$414-million (US$338.2 million) purchase of natural gas assets in northeastern British Columbia from Virginia’s Dominion Resources.

The acquisition of long-life properties by royalty trusts has been a topic of some debate in Canada for the last several years. As the basin has matured, more trusts have been formed, picking up declining assets and exploiting them, while paying out dividends to shareholders. Right now, there are about 30 energy trusts in Canada.

There is also some speculation that the combination of increasing costs, higher interest rates, and the growing strength of the Canadian dollar versus the US greenback could spell trouble for trusts. However, most warnings sounded about them over the last few years have proved to be unwarranted.

Meanwhile, the federal government has dropped a proposal to limit foreign investment in royalty trusts. The Federal energy minister had proposed to give Canadian trusts until Jan. 1, 2007, to ensure foreign ownership did not exceed 50%. The feds are concerned that they are not collecting enough tax revenue on disbursements to foreign unit holders.

On the provincial side, revenues continue to swell, buoyed by high commodity prices. Alberta, for example, is now projecting a budget surplus of C$5.7 billion (US$4.7 billion) for the fiscal year ended March 31, 2005, due primarily to oil and gas price levels that exceeded government forecasts.

Drilling. With the amount of dollars flowing into the oil patch, forecasts for the year are unusually optimistic. The optimism stems partly from the glow of a record drilling level drilling during 2004.

According to the Daily Oil Bulletin, there were a record 21,671 well completions in Canada, more than 8% higher than the previous record of 19,955 set in 2003. Drilling for gas continues to drive the surge in activity, representing 73% of last year’s completions (15,674 wells, also a record). There were 4,438 oil wells, 1,282 dry holes and 277 service wells. About 24% of the total wells were exploratory. In 2003, there were 14,050 gas wells drilled (70.4%), 4,473 oil wells (22.4%) and 1,233 dry holes (6.2%).

The high activity levels should continue in 2005, and the major Canadian drilling and service associations are both predicting another record. In the face of such high activity, both associations have also identified a lack of skilled labor as the single, most significant challenge facing drilling and service contractors. The upside to the higher demand for their services is that contractors have also seen day rates increase, which should translate into outstanding financial performance for the year.

The Canadian Association of Oilwell Drilling Contractors forecasts an 11.7% increase in drilling this year, to 24,205 wells. The CAODC based its forecast on an average WTI price of US$40/bbl, and an average spot natural gas price of C$6.12/Mcf at Alberta’s AECO-C hub. CAODC noted, however, that these price assumptions are conservative compared to most at this time. CAODC also predicts that rig utilization will average 64% in 2005, with an average rig count of 473, up 9% over last year. In 2004, rig utilization was 62%, with an average 418 rigs working.

The Petroleum Services Association of Canada has forecast a very similar drilling number for 2005, projecting 24,035 wells will be drilled (up 10.9%). PSAC believes that shallow, gas well drilling in Alberta, including development of coalbed methane (CBM) reserves, will be the focus of much of the activity.

CBM development in Alberta continues to be the focus of much speculation and debate. Some analysts, such as Calgary’s Ziff Energy, are bullish. Ziff predicts that CBM output will double by the end of 2005, to 230 MMcfd, and could reach 2 Bcfd by 2015.

This outlook is echoed by Canada’s National Energy Board, which forecasts an increase in CBM production to 450 MMcfd by the end of 2006. NEB sees an increase in overall gas deliverability to 16.9 Bcfd by the end of that year, compared to 16.6 Bcfd in 2003.

Meanwhile, in late 2004, and early 2005, World Oil conducted its annual survey of Canadian producers. Survey participants continued the bullish outlook, indicating they plan to drill 12,725 wells in 2005, up 9% from the 11,661 wells they drilled in 2004. This would roughly translate to a projected industry-wide total of 23,188 wells to be drilled in 2004.

For the first time in many years, World Oil’s survey participants have come in with a lower forecast of activity than the associations. However, the participation rate from Canadian companies in this survey is also one of the highest ever (55% of the entire country), suggesting that World Oil’s forecast number may better reflect industry’s drilling plans for the year ahead.

Not surprisingly, gas drilling will comprise a very high percentage of drilling in 2005, comprising 77% of the survey total (9,780 wells). The survey also shows an increasing focus on development drilling, with just 8.2% of the wells (1,064) expected to be wildcats. In 2003, the percentage of wildcats drilled by survey participants was slightly higher, at 8.9% (1,048), a continuation of a trend seen in Canada over the past decade. Activity is expected to increase 9.4% in Alberta and 8.4% in British Columbia, and decrease 19.9% in Saskatchewan.

Despite the fact that the search for oil and gas has been increasingly difficult with each passing year in the Canadian Western Sedimentary basin, one of 2004’s highlights was Shell Canada’s 800-Bcf gas discovery in the foothills of the Rocky Mountains, in southwestern Alberta. The company drilled a 5,100-m (16,732-ft) horizontal well, which encountered about 140 m (459 ft) of net pay in a previously untested Leduc reef. Well test results indicated a restricted flow rate of 30 MMcfgd. The company will delineate the field through further drilling this year.

Production. Despite the discovery, more and more of producers’ focus is on oil sands development, enhanced oil and gas recovery in mature fields, deep gas, and offshore and far north developments.

As regards oil sands, the advantages of knowing exactly where the resource is, how to get it, and how much you have, are offset by the massive capital costs and logistical problems associated with any big project.

For example, Canadian Natural Resources has seen the cost estimates for its proposed 232,000-bpd Horizon mining project rise to C$9.7 billion (US$7.9 billion) over its three phases, compared to previous estimates of C$8.5 billion (US$6.9 billion). The company blames rising steel, fuel and labor costs for the upward revision. The first phase, alone, should cost between C$6.1 billion (US$5.0 billion) and C$6.6 billion (US$5.4 billion).

And when things go wrong at a large facility, the implications can be enormous. In early January, a fire broke out after two explosions occurred at Suncor’s oil sands mining facility, north of Fort McMurray, Alberta. Located at the site’s Upgrader No. 2, the fire forced 250 employees to evacuate the area, and it reduced the plant’s productive capacity to 110,000 bpd. This compares to the normal 225,000 bpd, pending completion of an investigation into the incident.

Despite the difficulties inherent with oil sands operations, the Athabasca area continues to see substantial growth, reflected in the 7% increase in oil sands mining reserves reported by the Canadian Association of Petroleum Producers at year-end 2003. Industry has invested more than C$27 billion (US$22 billion) in the area since 1996, noted CAPP, and oil sands now represent 61% of total Canadian crude oil and equivalent reserves.

As regards conventional oil, output last year averaged 1.573 million bpd, down 4.7% from 2003’s level. Offshore output comprised 20.5% of the total, or 323,000 bpd. Producing oil wells numbered 57,082 (90.4% on artificial lift), of which 27 (all flowing) were offshore.

On the East Coast, more bad news and controversy has been going on than drilling, highlighted by a turf war between Newfoundland and the federal government. The fight, which is over royalty revenues from offshore projects, caused Newfoundland to remove Canadian flags from provincial buildings. Newfoundland’s premier ordered the removal to show his displeasure with an offer from the feds on offshore royalties that he characterized as “disrespectful.” The federal government reduces other payments made to the province by 70 cents on every dollar that the province collects in royalties.

There have also been a number of problems at Petro-Canada’s Terra Nova oil field, including a suspension of activity prompted by two spills that occurred while flow-testing a well last November. Although the amount of oil discharged during the two events was relatively small and quickly dispersed, oil output was suspended while the company and the government conducted investigations. The restart was further delayed by maintenance, but output resumed at the 160,000-bpd facility in mid-December.

Government land sale bonuses fell just short of record levels in 2004, but remained strong, particularly in Alberta, where revenues topped C$1.1 billion. In total, provincial authorities collected $1.42 billion last year. 

Mr. Curran is a Calgary-based freelance writer.

What 31 Canadian drillers plan for 2005