The Very Bearish Case for Canadian Natural Gas


Alberta Gas – All Dressed Up and No Place to Go?

By Chris James, CFA
Canadian natural gas prices could drop by well over half in 2015 as new pipelines allow very cheap Marcellus gas to flood North America says a November 4 report by Canadian brokerage firm Macquarie Securities.

The report–titled Red Dawn–says Marcellus gas could displace western Canadian gas in Ontario, the Midwest and even the US west coast–forcing Canadians to accept huge discounts in their gas prices just to be able to sell their natural gas at all.

The report outlines how inter-connected the North American gas grid is.  And a huge flood of Marcellus gas is already changing gas flows across the entire continent.  Macquarie outlines TEN new pipeline flow increases into the Midwest, FIVE into the US Northeast, and THREE into eastern Canada.

chart 1


Research by independent energy consultants RBN Energy show even more–they say there are now more than 50 pipeline projects underway which will increase Marcellus takeaway capacity by more than 28 billion cubic feet per day!

Macquarie says as Marcellus gas floods the Midwest–a big Canadian export market–US gas from the Rocky Mountains will back up, lowering its prices, and make it more able to compete against Canadian gas in the Pacific markets. Macquarie’s conclusion:

“The biggest loser, from a price perspective, is AECO, as it loses three of its former demand destinations. This should result in significant AECO discounts, in order to become more competitive.”

chart 2

AECO stands for Alberta Energy Company, and is the Canadian benchmark price for natural gas. Consider it another “hub” like Henry Hub in the USA. In the above graph, AECO gas prices are the red line and Marcellus gas prices are the blue.  Macquarie suggests that most of North American gas prices will have to come down to low-cost Marcellus prices to compete, once pipelines can transport it to most of North America.

Canadian gas prices–being the farthest from US markets–will have to absorb higher pipeline transportation costs to get to market–creating big price discounts.

How significant could these price discounts be?  Macquarie’s math suggests the actual October 2014 average price of $3.33/mmbtu would have been only $1.40/mmbtu with cheap Marcellus gas spreading out across the continent in new pipelines. That’s a 58% haircut.

This chart shows the AECO discount to US gas (NYMEX) is already widening.

chart 3

Growth in natural gas production in the low-cost Marcellus is absolutely stunning–and it has been slowly eating away at Canadian markets for a few years.  But now that pace should pick dramatically with several new pipelines getting gas north, south east and west of the Marcellus.

At the end of 2010, gas production from the Marcellus averaged less than 3 billion cubic feet per day (BCF/D) but that had skyrocketed to over 19 BCF/D recently.  Marcellus gas accounts for 98% of all U.S. production growth since September, in spite of facing pipeline restraints to deliver the gas out of the region.  US gas production hit an all time high of 71.9 BCF/D in late November.

If this producing area was a country, here is how they would stack up in terms of daily production according to the most recent statistics from the International Energy Agency (“IEA”);

  1. U.S.               66.7 billion cubic feet per day
  2. Russia            64.9
  3. Marcellus       19.1
  4. Qatar             15.6
  5. Iran               15.4
  6. Canada          15.0

Industry consultants RBN Energy estimate Marcellus production reaching 30 BCF per day by 2018 – that is just four years away and will be greater than the combined production of Norway, China and Saudi Arabia.

As a result of the past several years of low prices, natural gas has already made great inroads in the U.S. energy market supplying more than half of all U.S. homes and a third of power generation.  But the powerful coal lobby in Washington and lower oil prices means that gas will have a tough time increasing its domestic market share.

More natural gas demand is coming, however.  There are numerous projects (new LNG export facilities, major industrial projects) ramping up in the Gulf Coast, but these are at least two or three years away.

So where does all this cheap Marcellus gas go?

There are at least five major corridors, three of which could have a major negative impact on Western Canadian producers:

  • North to Sarnia, Ontario where it enters the established Eastern Canadian pipeline system and will compete with Western Canadian gas which currently enjoys premium (anything above Marcellus pricing is premium)
  • West to Chicago and the Midwest, another market currently paying premium prices and served by Western Canadian supplies. In time, excess gas will flow all the way to the U.S. West Coast
  • South via Ohio to the Gulf Coast market where Canadian gas is currently shipped
  • East to the fully satisfy the needs of the nearby Northeast market in the U.S. and Eastern Canada
  • South via the Atlantic also serving power plants as it makes its way to the Gulf Coast

What about pricing?

Macquarie suggests that producers of dry gas in the Marcellus (northeast Pennsylvania) have a breakeven price of only $2.50 per million BTU’s but the producers of wet gas (southeast Pennsylvania and Ohio) reduce that breakeven cost to only $2.00 through the sale of associated natural gas liquids (NGLs). (And I’ve seen cost projections from other sources that show Marcellus gas with a breakeven MUCH lower–near zero.)

Gas producers in other US basins like the Eagle Ford, Permian, Williston and Anadarko, just to name a few, aren’t going to sit back and lose volumes–so this will bring additional pricing pressures into the entire North American marketplace.

The same goes for Western Canadian producers.  They’ll have to fight for market share on price and not be able to command premium prices to Marcellus gas in eastern Canada and the U.S. Midwest like they are now.

But an equally large looming threat is that of Marcellus gas flowing further west to the major north-south pipeline network feeding the Gulf Coast so that Canadian producers will have a real battle just to get pipeline capacity to take their supplies.


The bearish case gets worse for Canadian gas.  Canadian brokerage firm First Energy is reporting that production in western Canada–which has been coming down by close to 1 BCF/D for the past few years–is now actually up 0.65 BCF/D over last November’s rate.

And RBN Energy just completed a two part series on how ethane prices in the US have been crushed due to over-production, especially in Texas.  Ethane is a Natural Gas Liquid (NGL) that gets produced along with regular “dry” natural gas (which is called methane).  Ethane is the feedstock for ethylene, which is used in anti-freeze in car engines.

RBN estimates that within two years close to 1 BCF/D of ethane will be rejected by industry, and just put back into the regular dry gas stream. Because it has an 80% higher heat content than methane, it actually displaces more gas than 1:1- which means the purchaser can buy a lot less gas!

One bullish bit of information is that Alberta gas storage could be under 300 BCF soon, with a cold November already in the books.  Alberta is normally around 425 BCF now–300 BCF normally doesn’t happen until February, putting the province three months behind its five year seasonal average.

So where does this all end?

If Macquarie’s scenario plays out, many operators (and possibly entire regions) with high cost production may have to shut in production at least on a temporary basis sometime in 2015.

This will take some supply out of the system. Until the Marcellus peaks in production, Canadian producers could be forced to accept gas prices so low it’s not economic for them to produce.  That could usher in a wave of consolidations that could be very profitable for nimble investors.

+Keith Schaefer

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