Elliott Gue and Peter Staas covered how pipeline capacity constraints, coupled with rising US production of light oil, have weighed on price realizations for Canadian upstream operators at length in Top Canadian Energy Stocks. I also addressed these trends in my inaugural contribution to Energy & Income Advisor, Introducing Roger Conrad’s Canadian Coverage Universe. 

In this Graph of the Week, we examine the interaction between the Canadian and US natural-gas markets. Although upstream operators have benefited from the recent recovery in natural-gas prices, many Canadian producers and oil-field service names that focus on gas are disadvantaged relative to their peers south of the border.

For one, price realizations at the AECO hub in Alberta, where TransCanada Corp’s (TSX: TRP, NYSE: TRP) Nova Gas Transmission system connects to Foothills Pipeline and Alberta Natural Gas, are inferior to those at the Henry Hub.

Source: Bloomberg

In the US rising shale gas production has depressed natural-gas prices  have weighed on the market value of this commodity.

Source: Bloomberg, Energy Information Administration

However, unlike in the US, Canada’s gas output has actually declined steadily in recent years–a trend that the country’s National Energy Board expects to continue into 2013.

Source: BP Statistical Review of World Energy 2012, National Energy Board

In part, this declining production reflects the highly interconnected nature of the US and Canadian natural-gas markets. The upsurge in US production from unconventional plays has displaced pipeline imports of Canadian natural gas, which have declined by almost 18.5 percent over the past four years. 

Source: Energy Information Administration

Meanwhile, US exports of natural gas to Canada (primarily from Michigan and New York), have increased considerably in recent years.

Source: Energy Information Administration 

What are the implications of these developments? Canada’s natural-gas production has declined primarily in higher-cost basins, while drilling in emerging plays such as the Liard Basin has slowed considerably. The development of the Montney Shale in British Columbia, on the other hand, has continued apace because of the field’s superior economics.

Investors should focus on low-cost producers such as ARC Resources (TSX: ARX, OTC: AETUF) and Peyto Exploration & Development Corp (TSX: PEY, OTCS: PEYUF)–provided that their shares trade below my buy targets. We also expect further consolidation  among acreage holders in the Horn River Basin, an unconventional play in British Columbia that could supply a number of proposed facilities to export liquefied natural gas (LNG) to Europe. We’ll highlight potential takeover plays in a future issue.