Alberta's Duvernay: What's driving demand in tight gas deposit?

Could the Duvernay become one of North America’s most attractive liquids-rich plays?

Most analysts think so, although the Alberta pocket of tight gas and natural gas liquids deposit still has some way to go.

“The Montney is proven,” says Bill Gwozd, senior vice-president, gas services at Ziff Energy Group in Calgary. “Duvernay has not yet been fully proven out, but it is emerging to becoming one the top five plays in North America — it’s not there yet. We need five to six years in development time.”

Duvernay has not yet been fully proven out, but it is emerging to becoming one the top five plays in North America

The early birds have already swooped in to pick up acreage in the area. The Montney and Duvernay areas saw a record 446 land leases sold in 2011, with the smaller, remnant positions in the two plays mopped up this year.

Encana Corp. and Canadian Natural Resources Ltd., Canada’s top two natural-gas producers, hold the largest positions in the play, while Talisman Energy Inc., Bonavista Energy Corp. and Celtic Exploration Ltd. also have sizeable acreage.

With the best locations already taken, energy giants Exxon Mobil Corp. and PetroChina Ltd. have gone the acquisition route to join the play. Given the natural gas economics these days, they didn’t find much resistance.

“Natural gas prices today in Western Canada are not quite enough to offset all the costs, so it can be attractive for producers to sell off the land, and get their sunk cost at rack rate,” Mr. Gwozd said. “And then on a go-forward basis, all they have to do is spend on operating costs.”

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Encana appears to have done just that when it sold a 49.9% interest in the Duvernay last week to Phoenix Duvernay Gas, a wholly owned subsidiary of PetroChina, for $2.18-billion. About 50% of the land is located in the prized Kaybob area, while the remainder is in the promising southern areas of Willesden Green and Edson.

Meanwhile, Exxon Mobil and its subsidiary, Imperial Oil Ltd., have bought Celtic Exploration Ltd. for $3.1-billion, attracted by its Montney and Duvernay holdings.

“Celtic could be a part of a longer-term West Coast LNG scheme that could see JVs or further acquisitions down the road,” RBC analyst Greg Pardy said in a note. “Given the capital intensity of the play, we expect players to seek partnerships to gain access to capital. Developing large land positions will require multibillion-dollar investments. We also see the potential for the larger players to acquire companies that complement their acreage positions as the play’s sweet spots emerge.”

Talisman could also look to sell some Duvernay acreage, chief financial office Scott Thomas said recently at a conference. Meanwhile, Calgary-based Angle Energy Inc. is seeking joint ventures or other capital funding in 2013 to get “ideal value” for its 46,000 acres of Duvernay, says chief operating officer Heather Christie-Burns.

But for now, the Montney remains the No. 1 shale play in Canada, with its combination of gas and natural gas liquids — propane, butane and ethane, among others — making it economical at $2.50 per mcf of natural gas. Meanwhile, the far less-developed Duvernay is breaking even at $3.20, according to estimates by Wood Mackenzie.

“If you look at the well breakeven costs of the Duvernay, it could soon be rivalling that of the Montney,” Hugh Hopewell, a senior analyst at the energy consultancy, said in an interview.

Bernstein Research’s Neil Beveridge likens the Duvernay to the mighty Eagle Ford, although costs of operating in the prolific Texas play are half those of the Duvernay.

“Given the greater depth of the Duvernay and location, drilling costs are more expensive than the Eagle Ford.”

The Duvernay has been also gaining ground over Horn River. The dry-gas deposit located in British Columbia was seen as the most likely beneficiary of Canada’s LNG plans given its proximity to the West Coast, but is now seen out of favour at $4 per mcf breakeven costs.

“Part of the Duvernay is very high in rich liquids,” says Mr. Gwozd, who says the “slower sister” Horn River could still come on line once the LNG plans kick off in earnest. “In the Duvernay, gas is the cake and you get a lot of icing with liquids — the amount of liquids they are producing can double the net value of the product — you can get an additional $3 for the liquids for a total value of $6.”

Expect Asian names to lead the race for joint ventures, says Mr. Gwozd. who was in Asia recently explaining the immensity of Western Canada’s shale riches to investors in the East.

“We will see [Asian] players looking to secure gas so they can bring it back home. The countries that would have interest in Canada in Montney, Horn River and the Duvernay, will include Malaysia, Vietnam, Singapore, India and the Philippines.”

But investments in the Duvernay don’t depend entirely on Canada’s LNG plans.

“LNG’s certainly an element, but given the liquids content that the Duvernay provides, you put it in context of a growing oil sands industry in the country,” Mr. Hopewell says. “Condensate production from the Duvernay could be used for diluents for transportation of bitumen through pipeline — there is a market to support the play within Alberta.”

These options are important as Western Canadian tight gas and shale gas potential has been overshadowed by the prolific and massive plays such as Eagle Ford and Marcellus south of the border.

And while the U.S. shale revolution has grabbed all the headlines, Albertan unconventional oil and gas resources estimates have also received an upgrade.

The independent Energy Resources Conservation Board’s best estimate for the Duvernay suggests 443 trillion cubic feet of natural gas and 61.7 billion barrels of oil in place. This makes the Duvernay Alberta’s second-most-promising play after Montney, which promises 2,333 tcf of gas and 136.3 billion barrels of oil in place, according to the ERCB’s latest estimates.

However, not everybody is convinced the Duvernay is ripe for drilling. Canadian Natural Resources Ltd., which has the largest holding in the Duvernay, is waiting for better economics before it will act.

“I would say from what we’re seeing right now, the rates are a little less than what we would expect to see a very economic return on capital,” CNRL president Steve Laut told a conference call this month. “So, right now, we are being cautious and taking our time to make sure we understand what’s going on, but I’d think rates would have to be a little better than what we are seeing right now.”

CNRL, which remains bearish on natural gas, plans to cut production and spending on its natural gas resource in 2013.