As work on Albertas oil sands booms, the slide in natural gas prices has meant a retreat in the face of high costs

As work on Albertas oil sands booms, the slide in natural gas prices has meant a retreat in the face of high costs

Canada’s oil-soaked sands are hot while natural gas drilling has cooled, illustrating the long-term nature of one business and shorter-term vulnerability to price swings of the other, analysts say.

“The economic life associated with these projects is measured in years, if not decades, as opposed to a 45-day gas well in Canada,” said Bill Herbert, co-head of research for Simmons & Company International in Houston.

Companies are capitalizing on Canada’s vast oil-soaked sands in northern Alberta, largely seen as a stable, long-term source of reserves in a friendly country unfettered by geopolitical uncertainty.

But natural gas prices that are half or less the level reached after 2005′s devastating hurricanes and the phasing out of tax benefits of Canadian investment trusts have prompted producers to pull back.

“A lot of marginal drilling activity taking place last year is probably gone for good,” Herbert said. Canadian exploration and production companies “are showing capital discipline with respect to not choosing to pursue the same level of drilling activity that they once were.”

On the oil side, Royal Dutch Shell this week bought out minority shareholders of its Shell Canada unit to increase its footprint in the sands.

Houston-based Oil States International’s accommodations division is pouring $58 million into lodging for oil sands workers for Canada’s Suncor Energy Services and Albian Sands Energy, which operates a joint oil sands venture of Shell and Chevron Corp.

And last year Houston-based ConocoPhillips forged a joint venture with Calgary’s EnCana Corp. in which EnCana will extract the oil and ConocoPhillips will process it in two upgraded refineries.

Canada has 179 billion barrels of proven oil reserves ”” second only to Saudi Arabia. Of those reserves, 97 percent are attributed to the sands’ tarlike oil that must be heated or mixed with other hydrocarbons to flow, according to Scottish energy consulting firm Wood Mackenzie.

“It’s essentially a sure bet because the oil sands is sound oil,” Wood Mackenzie oil analyst Conor Bint said.

Such investments are more expensive than conventional oil production because so-called heavy oil like that extracted from oil sands requires much processing to be converted to usable crude. Light oil, like that in the Middle East, is more user-friendly from the start.

Phil McPherson, director of research for C.K. Cooper & Co. in Irvine, Calif., said conventional oil production from Saudi Arabia costs $5 to $6 a barrel, while extracting tarlike bitumen from oil sands to convert to crude costs $20 to $25 a barrel.

But companies are increasingly willing to invest. Currently, Canada produces about 1 million barrels of heavy oil a day. The Canadian Association of Petroleum Producers anticipates that production to increase to 2.5 million to 3 million barrels per day by 2015.

And in January, the Energy Information Administration reported that Canada surpassed Saudi Arabia as the top supplier of crude oil to the United States. Of the 9.62 million barrels per day in total imports, 1.85 million came from Canada. Saudi Arabia came in second at 1.56 million.

McPherson said that data shows that Canadian oil sands production is “rapidly becoming more important” to U.S. crude oil supply.

The natural gas picture is more muted as producers roll back drilling to adjust to softer natural gas prices in an environment of elevated finding costs and seasonal demand contraction.

Herbert said an average of 572 drilling rigs were at work in the fourth quarter of 2005, when natural gas reached $15 per million British thermal units. That rig count fell 23 percent to 441 in the fourth quarter of 2006, when natural gas prices were half the prior-year level.

More recently, in the last three weeks, an average of 268 rigs operated in Canada ”” a 53 percent drop from the 574 rigs in operation during the same period last year.

“It’s a blood bath,” Herbert said, noting that Simmons anticipates the second quarter to show a count down 40 percent from the year-ago level.

The Canadian Association of Oilwell Drilling Contractors anticipates 19,023 wells will be drilled in Canada this year ”” down from 22,575 wells drilled in 2006.

At least two oil-service companies with exposure in Canada are feeling the squeeze. Houston-based Halliburton Co. and Nabors Industries have each warned investors that they expect first-quarter results to fall short of analyst expectations in part because of fewer rigs operating in Canada.

Precision Drilling Trust, Canada’s largst oil-field-services company, said in its annual report released late last month that declining demand in 2007 left too many drilling rigs. A severe or persistent decline in demand “may result in opportunities for industry consolidation,” the company said.

Another factor in the pullback is the Canadian government’s recent abrogation of investment trusts, Herbert said.

Such trusts buy and hold income-producing businesses ”” such as small producers ”” distribute all their cash flow to investors at a lesser tax rate than corporations have to pay on their income. The Canadian government increased taxes on new trusts.

McPherson said that additional tax burden has siphoned incentive for startup producers that would otherwise drill on the expectation that a trust would acquire their assets within a few years.

“With that exit strategy gone, the incentive to do this frontier exploration is not as great. They don’t have that natural buyer for their assets two or three years down the road,” he said.

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