High and volatile oil prices to continue

30 May 2007

Oil

One of the main reasons for today's crude price is that oil demand continues to grow while supply growth is just keeping pace. As a result, spare production capacity is now estimated to be only about 2 million barrels per day (MMb/d). This is a slight improvement over the same period last year, but still well below what most analysts believe to be adequate to cover any significant supply disruption.

Supply disruptions arising from geopolitical events increase the risk for higher oil prices.

Geopolitical issues continue to be a threat to oil supply around the world. Production at risk in any of these areas could easily exceed the estimated spare producing capacity of 2 MMb/d.

In addition to these geopolitical threats, the impact of weather on oil production and refining capacity is also a concern. For example, hurricanes in 2005 caused major production losses and refinery damage, all of which resulted in significantly higher crude oil and product prices.

Gasoline prices will follow oil prices.

Gasoline pricing is primarily determined by the price of crude oil. There are, however, some factors specific to the U.S. gasoline market that could also impact gasoline prices in Canada this summer:

• Currently, gasoline inventories in the U.S. are near historic lows.
• Demand for gasoline hits its peak during the summer driving season. There may be some tempering of demand due to consumer response to high prices. A slowdown in the U.S. economy could also lessen gasoline demand.
• Global refining capacity remains very tight. Refinery downtime in the U.S. has been particularly high in 2007. Any further unplanned disruptions will further constrain gasoline supply and put upward pressure on prices.

Natural Gas

North American natural gas supply: Canada down, U.S. onshore and U.S. liquefied natural gas imports up

Stronger U.S. production and higher liquefied natural gas (LNG) imports into the United States will offset lower Canadian production this summer.

Canadian production could be down an average of 500 million cubic feet per day in 2007 in comparison to the previous year. So far this year, Canadian drilling activity is weaker than it was at the same time in past three years. Annual increases in drilling activity and connection of new gas wells are necessary to maintain stable Canadian gas deliverability, because the productivity of new gas wells in the Western Canada Sedimentary Basin (WCSB) has declined.

LNG imports into the U.S. were 50% higher in January to April compared to the same period last year, because of depressed pricing in Europe due to a mild winter. LNG imports are not likely to be as strong after the summer if European weather returns to normal, but should still benefit from more LNG supply becoming available as exports start from Equatorial Guinea as early as June 2007.

Enough natural gas to meet summer demand for air conditioning and to refill gas storage for winter, providing there are no major hurricanes.

The anticipated pace of North American gas storage injections in 2007 has the potential to be almost as strong as last year, about 4 trillion cubic feet, filling storage in preparation for the winter heating season.

Major weather forecasters agree that conditions this summer support the potential for above-average hurricane activity. The hurricane season typically begins on June 1 and lasts until November with the peak hitting in August and September.

Natural gas prices will remain strong.

Natural gas prices are expected to remain between US$6.00-8.00/MMBtu over the course of the summer. Price movements outside of this range may occur in the event of exceptionally hot weather, hurricane-induced supply disruptions or strong storage injections.

Competition with fuel oil as the energy supply in multi-fuel capable facilities, have typically helped to connect the price of gas to that of fuel oil products. Usually when gas is plentiful, it will trade towards the lower end of a fuel oil price range bounded at the bottom by residual fuel oil (RFO) at the high by distillate fuel oil. With crude oil prices forecast at around US$65/barrel, the lower end of the fuel oil range would see gas at $6.00 to $8.00/MMBtu. Last summer, gas prices fell below the fuel oil range and competed with coal in the power generation market.

Electricity

Adequate electricity supply this summer

Provinces and territories should all have an adequate supply of electricity to meet summer loads.

With the exception of Ontario (due to its large cooling demand), the rest of the country tends to have winter-peaking systems. This is why there is usually a supply of electricity available for export in the cooling season, and that should again be the case this summer.

Alberta's electricity generation is expected to be adequate, but signs could start to appear (such as higher prices, increased volatility, and increased frequency of power warnings issued by the Alberta Electric System Operator for short-term declines in surplus available generation capacity) that its supply/demand balance is tightening and its reserve margin is decreasing.

Meeting medium to longer-term generation and transmission needs

A number of provinces have introduced or are in the process of introducing plans to address supply adequacy needs by way of new generation and transmission projects. For example:

• British Columbia Transmission Corporation's $3.2 billion 10-year transmission plan and the provincial government's BC Energy Plan;
• Alberta Electric System Operator's $3.5 billion 10-year transmission plan;
• Saskatchewan's plan to address its aging fleet of coal-fired generators (July 2007);
• Ontario Power Authority's Integrated Power System Plan.