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NGLs drive Duvernay and Utica spending

Talisman and Chesapeake tout two new liquids-rich shale plays in Canada and the US

North America’s burgeoning gas-supply bubble is poised to grow even larger as producers on both sides of the Canada/US border tout potentially big shale discoveries in Alberta and Ohio.

Calgary’s Talisman Energy and Oklahoma City-based Chesapeake Energy each proclaimed first-mover advantage in liquids-rich shale gas in the Duvernay and Utica formations, respectively, plays that could add trillions of cubic feet to North America’s already sizeable unconventional-gas reserves.

Talisman’s John Manzoni said his company spent C$500 million ($520 million) in the second quarter to purchase 360,000 acres of shale-gas leases at Canadian Crown land sales. It would make Talisman the leading player in the emerging Duvernay shale, the country’s newest natural gas deposit.

Meanwhile, Chesapeake chief executive Aubrey McClendon claimed Ohio’s Utica shales could be worth $40 billion to his company after it spent $2 billion to buy 1.5 million acres in the US northeast state.

Both Duvernay and Utica are packed with natural gas liquids (NGLs) that fetch premium prices, despite low returns for the natural gas production that accompanies them. Consequently, big gas producers such as Chesapeake, Talisman and Calgary’s Encana have been looking to increase NGLs output to make up for losses in their traditional gas exploration and production businesses. North American natural gas is trading at around $25 a barrel on an energy-equivalent basis to oil (calculated at 6:1), or less than a quarter of the value of the liquids.

In a sign of how important NGLs are becoming to the bottom line of big gas producers, Chesapeake increased its capital budget by $500 million to $6 billion to accelerate drilling to more than 200 rigs, including 40 in Ohio by 2014. The high level of enthusiasm is justified based on the production results from just three wells, and core samples from nine more, it said.

Talisman’s measured approach

Although Talisman’s approach is more measured by comparison – two test wells are planned for the rest of the year – it said activity could quickly be scaled up depending on its own drilling results.

The differing approaches underscore the fundamental shifts in the North American gas market given the abundance of new reserves. With the proliferation of so many new supply sources, basins are competing with each other for market share and development capital.

All the more reason why Talisman’s Duvernay bid is a strategic bet on basin diversification – but could also be a bit of a gamble. Talisman had previously eschewed Alberta for greener pastures in Pennsylvania; at one point there was talk it might relocate its headquarters to Pittsburgh as the bulk of its field operations moved to the US.

But after an initial flush of activity, Marcellus Shale development has waned in the face of public and regulatory opposition to hydraulic fracturing (fracking). Although it is in a prime location, close to large consuming markets, land values in the Marcellus have fallen and there’s a sense that environmental critics have gained the upper hand in neighbouring states, such as New York that will limit the overall growth of the play.

That’s partly why attention has shifted to the Eagle Ford in Texas, where a freer regulatory environment and stronger social acceptance of oil and gas development has transformed it into North America’s fastest-growing unconventional-gas play. But competition is fierce and heavyweights such as ExxonMobil and Shell have begun to muscle their way into a scene that has previously been dominated by the relatively smaller independents, including Chesapeake and Talisman.

Retreat to higher ground

So Talisman’s Canadian homecoming can be seen as a retreat to higher ground, where it clearly has the home-field advantage – and fewer competitors. “It's very early days, but we're optimistic we'll see the Duvernay emerge as another successful liquids-rich play, this time right here in Canada,” Manzoni said.

Like Texas, Alberta has extensive gas-gathering and processing infrastructure and a friendly operating climate. At its peak in 2000, Canada’s largest petroleum province shipped almost a fifth of the gas produced in North America on its Nova gathering system – 16 billion cubic feet a day – infrastructure that is now barely half full. So there is a great economic incentive to find the extra volumes to fill it, notwithstanding the low gas price. Higher load factors translate into lower pipeline tolls, which benefit the entire sector.

The big question is if costs can come down enough to compete with US states such as Pennsylvania and Ohio as Lower-48 output continues to post some of the strongest production growth since the Second World War. Canada, which was (and still is) the largest source of US natural gas imports, is finding itself backed out of the market in the face of new, lower-cost supplies south of the 49th parallel.

According to Cedigaz, Canada’s gas production was the lowest in a decade in 2010, while the US’ is at its highest. The drop isn’t a reflection of dwindling Canadian supply, as much as an indicator of reduced capital investment and a shift of dollars into higher-margin prospects in the US. Although blessed with abundant gas reserves, Canada, and Alberta in particular, have become the high-cost producers. That would have been unthinkable a decade ago.

Canada’s competitive advantage

That’s not to say Canada lacks competitive advantage, given the extensive infrastructure that’s already in place. That would easily make Duvernay the most cost competitive gasfield in the country, well ahead of other big unconventional deposits, such as Horn River in northern British Columbia.

Unlike Duvernay, Horn River is dry gas and it’s far from the main processing hub, even by Canadian standards. Conversely, Duvernay is even further from downstream US markets and faces similar competitive challenges. Ohio, with its concentration of heavy industry, would seem to have an upper hand based purely on geography alone.

But much depends on a volatile legal climate and other political factors. The Ohio Utica is an extension of the Utica in Quebec, where development has essentially been halted over public opposition to fracking. Talisman has drilled a series of test wells in Quebec that are awaiting government approval, but has found itself stymied by overwhelming public opposition to drilling. Companies such as Chesapeake may find themselves hard-pressed to convince the public and lawmakers that jobs and investment trump environmental concerns.

In the meantime, supply dynamics are starting to exert even more direct influence over North American market fundamentals as new production basins shift gas flows on the continent’s integrated distribution networks. The only thing that’s missing – and what’s needed more than anything to restore balance to the market – is demand. That may prove to be an even tougher nut to crack.

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