It's no secret that Canadian gas prices are low now, but few investors realize how low it is compared to the U.S. The spread has recently been over $1/mcf, when it's usually about 70 cents - that's nearly a 50% jump.
And the reason, says one energy expert in the U.S., is because the Canadian industry (and this means the pipeline companies as well as the producers) is rapidly losing the most lucrative natural gas market in North America - the U.S. Northeast.
"AECO has to be lower," says Jack Weixel, director of energy analysis at Bentek Energy. Bentek analyses pipeline flows around the continent. AECO is the benchmark Canadian gas price.
"AECO is losing market share in the U.S Northeast, and also in the Midwest. To get its gas to the Northeast it has to lower its price. AECO has kind of already lost the Northeast, but it's also already going lower so it can ship gas to the Midwest. They have to lower their source price to be competitive with Henry Hub sourced gas or anywhere in the lower 48."
This confirms my view that the best way to play natural gas in Canada is to buy producers with high "wet gas" or "liquid rich" plays, or those with strategic land positions that make them takeover targets by bigger players in the industry. Wet gas (which contains condensate, butane, propane etc.) commands a price about 65% of crude oil, compared to dry gas (which is just methane) of 28%. I sent out a report to subscribers last month highlighting several junior and intermediate wet gas producers.
In a June conversation I had with Weixel, he estimated Canadian exports to the U.S. Northeast were down 23% year-over-year, and down 44% if you didn't include liquid natural gas sent from the Canaport terminal in New Brunswick. Volumes of Canadian natural gas flowing into the U.S. at the Niagara terminal in Ontario were less than 20% of capacity, and he added that there were talks going on about reversing the flow of the pipeline from the U.S. into the Canada, due to the growing Marcellus shale production.
The research team at Canadian brokerage firm National Bank Financial have been recently highlighting the difference in natural gas prices between the U.S. and Canada, which is called the Nymex/AECO spread - Nymex being the or New York Mercantile Exchange, where the US natural gas price is usually quoted from, and AECO, out of Edmonton, is the most quoted Canadian gas hub price.
"The Nymex/AECO basis spread has recently widened, averaging US$0.71/mcf since mid-June and more recently surpassing US$1.00/mcf in early July," they wrote in a recent report.
"This compares to a lower than historical Jan-May average US$0.21/mcf basis as cold weather brought U.S. storage levels down to five-year averages. The basis could widen further in 2011 with the commissioning of El Paso's 1.5 bcf/d Ruby pipeline."
The Ruby pipeline is being built from the Rockies through to Northern California, and has the potential to displace Alberta gas - removing another market for Canadian producers. Weixel says it will be a lowest-cost-gas-fight to see who wins the northern California market - the Canadians or the U.S. producers who fill the Socal pipeline. (The stronger Canadian dollar over the last few years has not helped the Canucks).
Despite Alberta production being down about 1 bcf per day year over year (which has happened every year for the last 4), Weixel says Alberta is oversupplied with gas.
"Alberta storage levels are 320 bcf, which is about 10 bcf, or 4% higher than last year. It's about 22 bcf or 8% than the 3 year average."
There was so much gas in storage in Alberta last year that the joke around Edmonton was you can't even smoke outside or the whole city would blow up if anyone lit up a match.
Weixel adds the situation is improving - In May, Alberta was 30 bcf higher in storage, and is now only 10 bcf.
With declining exports to the U.S., the pipeline companies have had to raise tolls per mcf to earn their regulated rate of return. While it's not a lot - one producer estimated to me about 10-15 cents per mcf - it's another small kick to these producers and their shareholders.
Lower provincial royalties have helped producers recently, but it's clear that unhedged producers - mostly the juniors - will have another rough summer, financially.