Copyright of the Daily Oil Bulletin 2018
Natural Gas Market Diversification Is Increasingly Important To Canada
Natural gas producers, once upon a time, were happy simply selling their hydrocarbons at AECO or Station 2 with little motivation towards market diversification, and letting the marketer and end user pick up the gas at the hub.
But fewer shippers, higher costs and the rise of shale gas meant a “death spiral” in the 2000s, according to Jihad Traya, manager of natural gas consulting at Solomon Associates. By the latter part of the last decade, he said, western Canadian producers were forced to recognize clear signals that traditional markets were changing.
“The smarter, more forward-looking producers started taking on transportation to hubs out of AECO, to Malin, Eastern Canada, [or] Chicago via Alliance or Northern Border. They started taking that up.”
He added: “When [TransCanada Corporation], a year and a half ago, announced another opportunity to deliver the Dawn market utilizing what is called the ‘long-term fixed price pass,’ the astute producers wanting to market their gas said, ‘yeah, I need to get onto that,’ and they started to take transportation.”
Unfortunately, Traya told the Bulletin, there are still many producers who will “stand on a pulpit and preach” about how “lowest-cost” are their operations, and why that enables them to survive at AECO. The fact is, though, every producer can be fairly close in efficiency to the lowest-cost producer, and therefore being market savvy is imperative to a contemporary company’s competitiveness.
“The producer with a path to monetization is actually the true winner. How you convert the molecule into the highest number of ‘gold coins’ is what determines the winner.”
In terms of managing commodity-price risk, Advantage Oil & Gas Ltd. has been an active hedger since 2009, hedging as much as 50 per cent or more of its natural gas, suggested Craig Blackwood, the company’s vice-president of finance and chief financial officer.
“Regarding market diversification, it’s a bit more recent — really just over the past couple of years. It began with our participating in the long-haul service to Dawn in Ontario, where we now take about 20 per cent of our gas.”
He added: “Basically, it has become more difficult to hedge with the future strip prices, and therefore market diversification has become a bit more of a prevalent tool to utilize in this environment. It doesn’t fix your cash flow, but at least it helps to spread around the risk associated with your cash flow.”
In another example, Tourmaline Oil Corp. began its market diversification strategy about five years ago, notedBrian Robinson, VP of finance and CFO.
“As the company emerged as a major North American natural gas player, we recognized the importance of accessing, and competing in, multiple gas markets,” he said, adding that Tourmaline is not reacting to currently oversupplied local gas markets in a way that weakens prices. “In fact, having our strategy in place ahead of the oversupply has allowed us to realize higher gains than those diversifying in the current environment.”
Encana Corporation was the first Canadian producer to really push for diversification in order to grow natural gas demand in response to the United States increasingly developing its own low-cost gas resource, said Edward Kallio, principal at consultancy Eau Claire Energy Advisory Inc. Over the last few years, even western Canadian gas flows to Central Canada have declined as a result of this abundant U.S. gas pushing into the Ontario and Québec market.
Kallio suggested there are three major themes in terms of market diversification that could prove critical to the future success of Western Canada’s natural gas industry, the first of which is LNG.
“That would be the biggest thing. With one sanctioned project, say LNG Canada, they would build two units right away, which would add 1.5 bcf/d of demand. If they were to expand by adding two more liquefiers, it could double it to 3 bcf/d. When you are looking at a current 14- to- 15-bcf/d market, it’s a very sizeable increase — 20 per cent.”
Domestic power generation and oilsands activity are the other two major sources of potential market growth that Kallio sees for western Canadian producers. However, he said, all three market possibilities have development barriers.
“A lot of these issues are ‘made-in-Canada’ issues. While some of these issues, for example the downstream on the LNG side, are issues outside of our control, we need to incent Canadian producers on reducing their costs, rather than penalizing them with carbon taxation and other measures that really impact their competitiveness standing vis-à-vis the major competition, which is the U.S. on the natural gas side.”
Need for ‘old school’ marketing; LNG is the answer?
Companies that can demonstrate (primarily to shareholders) they have marketing strategies are the ones to survive and thrive into the future, noted Traya. These strategies must be complex, requiring a much more intimate understanding of the market than is currently often the case.
“You need to be an expert on the petrochemical side, global LNG side, power market, downstream utility markets, pipeline tolls and tariffs structures, supply and demand, and macro-economic events.”
Success in terms of market diversification strategies comes down to anticipating future market conditions, according to Traya. Companies require better macro understanding of the natural gas business, and how Western Canada ties into the rest of North America.
“[Producers] will have to do something they were never accustomed to, and that’s finding customers one gigajoule at a time,” he said. “It’s about actually having an old-school marketing team that actually finds the downstream market for you. You’re not just screen-trading and dumping it at a hub.”
Regarding LNG, Traya said once it hits, that addition to the industry will be good for Canada’s broader macro-economy, and good for project proponents who eventually make an FID announcement, but LNG is not necessarily good for small Canadian producers.
In fact, he told the DOB, LNG probably can have a negative implication for those smaller producers, as a major company such as Royal Dutch Shell plc and its LNG partners would offer more competition for field development due to their newly-formed global market access.
“Participation in LNG for small producers isn’t very likely to happen, and until there is some sort of tolling LNG facility on the West Coast of Canada, it will never happen. There may be days in which you have higher-than-expected demand, but that does not necessarily mean AECO prices will elevate to a level that would give small producers a free ride to higher prices.”
While the degree to which Advantage plays into LNG directly is difficult to know right now, Blackwood said LNG is nonetheless extremely important and will benefit the entire natural gas industry in Western Canada.
“For LNG, I believe, it is actually critical to diversify for Canada. It is important for Canadians. It is important for our industry. It takes back control of our product and gets the maximum price for our natural resource.”
He added: “I believe there are opportunities there for Advantage, and we are having discussions with various parties, but I think in terms of getting natural gas off the continent to desirable marketplaces outside of the U.S., that will definitely benefit the whole market.”
Even if Canadian LNG proponents announced a project’s final investment decision immediately, though, it still would not solve Canadian producers’ problems in terms of natural gas prices, suggested Traya, as project proponents are dealing with stranded gas just like everyone else in Western Canada, and they are looking to monetize it.
“Further to that, the relationship with LNG — because you have LNG production in the Lower 48 — starts to become a balance for North American natural gas,” he said. “And so for western Canadian producers, they have to be even smarter about global LNG markets.”
According to Kallio, on the LNG file he expects supply and demand will come into balance around 2023-24 as Asian market prices rise and thus help resolve market-end issues. Hopefully, he said, by then the proponents for one or more of those Canadian projects can convince their boards into taking some risk.
“That market pricing isn’t there yet, but if you can get going and building a plant such as LNG Canada, then you can hit that next window with available supply. So there is hope there.”
A “made-in-Canada” issue in terms of this LNG market would be Canada’s current federal tax treatment regarding modules for would-be projects, he noted. Carbon taxation is also a hindrance: “[Canada] could cut the carbon taxation right off the bat, which will allow Canadian gas to be more competitive with the U.S.”
Help diversifying Canadian gas markets
While power generation could be an important potential market for western Canadian natural gas, increasingly Canadian governments, including Alberta’s, are looking at renewables to replace coal, rather than replacing it with natural gas, Kallio told the DOB. In his view, that is not a good solution for producers or consumers.
“Alberta could, instead of replacing with renewables the coal they are looking at shutting in, they could go with natural gas. You’d still get a 50-per-cent reduction in emissions by switching from coal to gas.”
He added: “If you look at the U.S. experience, there is no carbon tax. Yet, they have decreased emissions more than any other jurisdiction worldwide just by switching from coal to natural gas. We have a huge endowment of natural gas here, and I don’t know why we are not using more of it for power generation.
“In my view, that is a failed Alberta policy. That is a policy that is adding costs to producers and it is adding costs to power consumers.”
With regards to carbon taxation and favouring renewables over natural gas for power generation, once consumers “feel it in their pockets,” Kallio anticipates resistance and potential regime changes both provincially and federally.
“These are things where government policy has an influence, and unless you think this through all the way and understand the fundamentals, rather than just the ideology, you are going to have unintended consequences. Those chickens have come home to roost in Ontario already, and I fear Alberta is going to go the same way.”
Oilsands production represents the other big source of demand for natural gas out of Western Canada. By adding about 500,000 bbls/d in oilsands development, suggested Kallio, it would add about 500 mmcf/d of gas demand for natural gas producers.
In terms of increasing oilsands activity, however, he said the made-in-Canada issue is an inability to get the necessary pipelines approved and constructed. “That problem could be handled with good regulation and political will on the part of the federal government to impose rule of law, because that is federal jurisdiction — it’s not B.C. or Ontario or municipal jurisdictions.”
Kallio believes producers and organizations such as the Canadian Association of Petroleum Producers (CAPP) must be more forceful in advocating and pressuring governments to sanction pipelines that will improve market access.
Shippers and TransCanada could address current downstream egress issues by getting together to construct a deal that is good for all parties, and which allows more gas to enter Eastern Canada, Kallio added. “There are a lot of made-in-Canada issues we need to clean up in order to expand the natural gas markets for the Canadian producers.”
Blackwood told the DOB that he believes industry is doing enough in terms of facilitating market diversification for natural gas in Western Canada. However, he also thinks the business environment has changed relatively quickly, which makes it difficult for industry to adjust as quickly as would be the ideal.
“Lots of other companies have deployed different strategies — some have financial, some have physical contracts, and some have done other different things,” he said. “Some have gone to other different market points, and some have actually started to commit to other end users in terms of supplying gas that can be used in other products. Companies have deployed a variety of different strategies.”
He added: “We do have a system where we’ve grown supply significantly, and that has pushed up against some of the capacity out of the Western Canadian Sedimentary Basin. It has definitely made it more challenging to diversify versus what we would have done in the past, but I think many companies have been relatively successful doing that. It has, however, made it more complicated for everyone to understand how companies have managed that risk.”