Reuters  By Nia Williams

CALGARY Alberta (Reuters) - Canada is enjoying an unexpected boom in production of ultra-light crude known as condensate, defying long-held predictions of dwindling supply.

This surprising bounty from one corner of Alberta, better known as the home to Canada's vast tar-like oil sands reserves, is a boon for firms like Vermilion Energy Inc and Chevron who have built up positions in the Duvernay, now hotly tipped as one of North America's most exciting shale plays with vast reserves waiting to be tapped.

 It also is fuelling hope of cost relief for traditional heavy oil sands companies such as Cenovus Energy Inc, who in the past have paid premiums of up to $25 a barrel to buy imported condensate used to dilute their viscous oil sands production so that it can flow through pipelines.

The change in outlook has been abrupt. A year ago, the Canadian Association of Petroleum Producers expected condensate production to shrink from 139,000 barrels per day to barely 100,000 bpd by 2025, according to its annual forecast.

The group's updated forecasts, due out next week, will likely show a very different trajectory, according to Greg Stringham, vice president of oil sands and markets.

 "(Condensate) had been in decline. We are now seeing relatively strong growth," he said. He declined to give exact numbers until the report is released on Monday. In April, Canada's National Energy Board said it expected output to rise 13 percent this year to 172,000 bpd.

 While the growth is modest compared to the shale revolution that is upending the U.S. industry in places like North Dakota and Texas, its impact may reverberate far south of the border.

 Rising domestic supply is coming at a time of lower than expected demand for imported U.S. diluent because more companies are moving to ship bitumen by rail, which doesn't necessarily need to be diluted, instead of pipeline.

 As a result, the trends may further depress U.S. condensate prices and thus add to mounting political pressure to relax U.S. rules barring overseas exports.

 Along with a newly reversed Cochin pipeline that will start delivering up to 95,000 barrels per day of U.S. condensate from Illinois to Alberta in July, some producers are growing hopeful that prices may finally begin to ease.

 "I don't believe there's such a thing as cheap condensate. But all other things being equal, more supply coming into the basin should be a positive thing for the buyer," said Rick Dembicki, director of crude oil marketing at Cenovus, which sources half its condensate from outside the province.

 A LONG WAY TO DUVERNAY

 Condensate supply, though small, plays a critical role in the growth of Canadian oil sands, the world's third-largest crude reserves behind Saudi Arabia and Venezuela.

 Because raw bitumen is too heavy and thick to flow easily through pipelines, it must be blended with around 30 percent of a lighter oil, known as diluent. A number of different types of hydrocarbons can do the job - including condensate, natural gasoline and synthetic crude oil. The diluent is then stripped out by refiners or terminal operators at the destination, often to be pumped back to Canada and blended again.

 With oil sands production expected to nearly double over the next decade, demand for diluent is expected to surge to around 900,000 bpd in 2025, consultancy Wood Mackenzie said. Other forecasters suspect demand will be over 1 million bpd.

 Thanks to the recent boom in the Duvernay formation, a growing share of that may be met with Canadian condensate.

 Last month, Canada's Encana Corp said the northern Simonette area of the Duvernay was producing up to 400 barrels of liquids per million cubic feet of gas, more than twice the 150 barrels per million it had expected.

 Chevron's well performance and yields in the Duvernay had exceeded expectations with initial production rates of 1,300 barrels of condensate per day, Jeff Shellebarger, North America Exploration and Production, said last October. A Chevron spokesman said that was the latest production estimate.

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