By Paul Wells
Already weary and apprehensive because of rock bottom natural gas prices and uncertainty in the crude oil market, western Canadian producers are likely to become even more white-knuckled as a natural gas liquids (NGLs) glut begins to take hold.
Recently the near-term saviour for many companies, the rush to exploit liquids during a period of low natural gas prices has created over-supply, not unlike when the service sector overbuilds during a cyclical high, only to be hammered when the cycle descends.
Already, oil and gas companies in the United States that have depended on natural gas liquids to lift profits are beginning to rein in spending or sell some assets after the industry drilled its way into a glut of NGLs. And that trend has crept northward over the border where many Canadian companies are now facing the same predicament.
"Natural gas players that rely on natural gas liquids to make ends meet are feeling the pinch. That much is true. What's equally true, however, is that some natural gas players are feeling the pinch more than others. Not all natural gas liquids are created equal," noted Geoffrey Vanderburg, managing director with Bryan Mills Iradesso.
"Some of the more theatrical observers have said natural gas liquids are walking off the fracking cliff with natural gas. They believe the success of fracturing in liquids-rich shale gas plays has not only reduced the price of natural gas, it has also pushed down the price of natural gas liquids to the point where they're no longer propping up natural gas to the point of profitability."
Chris Theal, president and chief executive officer of Kootenay Capital Management Corp., said that with the exception of condensate, other liquids stripped from the natural gas stream continue to lose value.
He said that on average, NGLs were priced at about 55 per cent of West Texas Intermediate last year while in recent months it has been more in the 37 per cent range.
"I think where you're really seeing it is with the lighter liquids -- ethane and propane. Ethane is basically at the point where it is being rejected and left in the gas stream. It's a combination of supply that has been fairly robust and you've also had a lot of the crackers down for maintenance and expansion," he said.
"I think that underlying all that is that most liquids plays in Western Canada are probably half ethane and propane and those are more of the marginal products out of the whole liquids' stream. When you look at it, it's really only condensate that's strong in Canada."
Vanderburg said the reality is that the average NGL price is "all over the map," mostly because different liquids bring in different prices depending on the composition and destination of the liquids. In the first quarter of 2012, of 83 producers that trade in Canada and operate domestically and abroad, the average NGL price ranged from $18.39 per bbl for Antrim Energy Inc. to $112.80 per bbl for Corridor Resources Inc. The median was $63.37.
But Vanderburg added that the NGL volumes for the companies at the extremes of this list are low enough that an increase or decrease in the average price would have a minimal impact on their bottom line.
"The same cannot be said for companies with high liquids volumes. Companies with high liquids volumes will be hit to varying degrees depending on the volume and composition of their liquids," he said. "Condensate prices have been hovering around West Texas Intermediate oil prices while propane and ethane have been trading much lower."
Although they are sure to feel the hurt, Vanderburg said western Canadian producers have an advantage over their U.S. brethren courtesy of the oilsands.
"In addition to the composition of the NGLs, liquids producers in Canada can be expected to do better than their U.S. counterparts because of the higher demand for diluents in Canada. Oilsands producers use condensate as diluent to cut the viscosity of bitumen," he said.
"It is a key input for dilbit and synbit and there continues to be demand for that product. As a result, condensate and butane have been trading at a 20 per cent to 30 per cent premium in Canada versus the U.S."
Gary Leach, executive director of the Small Explorers and Producers Association of Canada, agreed that companies with proportionately stronger condensate output will fare better than those with assets that have more exposure to the lighter liquids.
"While prices for [lighter NGLs] are down significantly primarily due to a supply glut in those segments, prices in Canada for condensate have held up well due to demand from the Alberta oilsands for diluent product," he said.
"Companies who are fortunate to have higher exposure to relatively condensate-rich plays, such as the Cardium or Duvernay shale, will be less affected by the current pricing weakness for liquids."
Leach said that for many producers, oil and NGLs have been the major part of cash flow, even for companies whose production mix is heavily weighted to natural gas. And while many operators have announced reduced capital expenditure plans given low gas prices, volatile crude oil prices and the growing glut of liquids, it's unlikely the current supply-demand dynamics will change any time soon.
"The weaker than expected pricing of NGLs is undoubtedly a factor in recent decisions by some producers to reduce capital spending compared to previously announced targets," he said. "However, it will take more than a handful of companies reducing drilling to have any impact on the current North American liquids supply situation."
Bucking the trend to reduce spending is Encana Corporation, which recently announced its spending would rise this year by about $600 million as it speeds the search for NGLs and crude oil.
Encana aside, Theal expects that dwindling prices for the overall NGL basket will continue to force the hands of many producers.
"As you looked at the basin coming out of breakup, the overall NGL basket was down about 25 per cent price wise, when you put them altogether," he said.
"It comes down to the lift ... of the liquids in terms of the price yield -- it's just not as dramatic, and in some cases it's going to lead to a pullback in liquids plays that have a higher composition of ethane and propane."
Theal said that the true impact of lower NGL pricing won't likely be known until post-spring breakup drilling numbers continue to roll in and rig counts are updated.
"I'd be watching the liquids-rich plays in the Deep Basin to see what degree you're seeing a pullback because that's where I think it's going to kind of focus," he noted.
Vanderburg said that although the decline in NGL prices has been painful, there are "signs of optimism" about natural gas prices.
"Strong natural gas liquids prices have been a great antidote to low natural gas prices, but natural gas is where it's at in Western Canada. Low liquids prices will quickly be forgotten if they correspond to a strengthening in natural gas prices," he said.