Forget oil. Natural gas is the true energy crisis. In the 1990s, North American gas prices averaged $2.10 (all currency in U.S. dollars) per million British thermal units (BTUs), the standard industry measure. By the early autumn of this year, prices had shot above $14. That's more than a sixfold increase, compared with roughly a tripling in the price of crude oil over the same period.

The fat gas price has made small fortunes for investors and, in mid-September, turned EnCana, Canada's top gas producer, into the TSX's biggest company by market value. The bad news: Soaring gas prices and rapidly diminishing gas reserves are about to create a policy nightmare for Ottawa and the provinces.

Gas was supposed to be the cheap and environmentally friendly alternative to oil for heating homes, and to coal and nuclear power for generating electricity. Things haven't turned out as planned in recent years, due to falling reserves, booming demand, a hurricane or two and some spectacular gas discovery duds. To that list, add the decision by the Mulroney government two decades ago to deregulate the gas market. By November, 1986, the Diefenbaker-era system that controlled oil and gas prices and exports had been scrapped. The Canada-U.S. border disappeared and market forces prevailed.

That deregulation meant large amounts of gas no longer had to be held back for domestic consumption. The old so-called reserve requirement had been inspired by post-Second World War governments in Alberta. In a province that's frigid for much of the year, it made sense to stockpile gas for heating. The requirement, which later became national policy, essentially allowed energy companies to pump as much gas as they wanted and to export any surplus, but only as long as they kept roughly 25 years of reserves in the ground for Canadian demand.

The gas producers argued the requirement was bad economics and dubious social policy because it left them with vast inventories of gas that couldn't be converted into quick cash flow and profit. That meant they had little incentive to find more reserves, which distorted the gas supply-demand equation.

They were right. After deregulation in the mid-1980s, huge quantities of gas flowed into the market. Prices fell. Pipelines were built and exports took off. Millions of North American consumers bought gas furnaces, and dozens of new gas-fired electricity generating plants were built. After Americans became Canadian gas junkies, the 1989 Canada-U.S. Free Trade Agreement ensured their dose couldn't be cut off. As a result, Canada's gas production has more than doubled since the mid-'80s.

Five years ago, the inevitable happened: Gas prices began to rise. Thousands of new wells were punched into the ground every year, but proven reserves did not surge. Production is now on the wane, according to the Canadian Gas Association. Proven (though not potential) gas reserves are in precipitous decline. They peaked at 99 trillion cubic feet in 1984, but fell to 56.6 tcf by the end of last year. At Canada's current rate of consumption and export (gas exports now exceed domestic consumption by about 40%), that's enough to last about nine years.

Relax, say many resource economists. High prices will spur exploration and innovation, such as extracting methane gas from coal seams. But North American demand is expected to increase to 34 tcf a year by 2012 from about 27 tcf in 2003, according to some forecasts. Even with high production, cheap gas, like cheap oil, is gone. Gas prices could fall to $7 or $8 per million BTUs, but they will never go back to $2. They could easily stay well above $10 as shortages persist. Energy pessimists point to rapidly depleting wells and busted discovery dreams, such as British Columbia's incredible shrinking Ladyfern gas find of 2000. High prices can't find gas if the gas isn't there.

Ottawa and the provinces now have several big problems. Consumers will face big gas bills this winter. But electricity costs are rising as well. The squeeze is acute in Ontario. What would have been an easy decision five years ago--building more gas-fired plants to cure a looming electricity shortage--has been replaced by agonizing over the nuclear option because gas is now so expensive.

But all this is nothing compared to the real issue--Canada eliminated its energy security 20 years ago by ending the reserve requirement and then opening the door to exports it can't stop. At the time, trading off security for an industry boom and low prices for consumers seemed to make economic and social sense. That worked for a while. Blankets, anyone?

Eric Reguly, Globe and Mail Columnist