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Bearish Fundamentals Creep into Some Market Models

Some recent gas supply forecasts have been surprisingly bearish, showing domestic dry gas production growth at the same time that LNG imports are soaring. But Ron Denhardt of Strategic Energy & Economic Research said he's taking more of a "wait and see" approach.

"There are some indications that the fundamentals are bearish, but I'm not confident enough about them to go way below the forward market yet," Denhardt said. "Some are pointing to real downward pressure on prices, but there are some things like LNG flows that I'm not that confident about how it is going to play out yet to say the market is going to fall apart."

Denhardt noted in his monthly Natural Gas Seer report that substantial liquefaction capacity is scheduled to come online this year and target the U.S. market. "Approximately 1.2 Bcf/d (50% of Nigeria Trains 4 and 5 and 100% of Trinidad Train 4) is contracted to the U.S." Trains 4 and 5 in Nigeria are due to come online in July and November, while Trinidad Train 4 is expected in October.

Meanwhile, some data providers, such as the widely respected Lippman Consulting firm, are showing that record drilling activity finally is resulting in production increases. The most recent release of Lippman's gas model has U.S. natural gas production growing 1.5% in 2006 to 57 Bcf/d, another 1.4% in 2007 and 0.4% in 2008.

"This is a sea change from a history of essentially flat production and it contrasts sharply with the claims that U.S. production has been declining by 2% per year and will continue to do so," said Denhardt.

"I see some domestic production increases, but I'm more conservative [than Lippman]. On the other hand, some of these other predictions that are out there [showing sharp domestic production declines] such as Lehman Brothers' and Raymond James' are absurd. If you have demand growing and you are saying production is declining at 2% per year, how are you balancing the market? It just doesn't make any sense at all."

Denhardt said Lippman's gas model is "the best intermediate term model on the market. However, data problems and the difficulty of predicting deepwater finds [one of which can substantially change the forecast] means that there is substantial uncertainty about the natural gas production outlook." As a result, Denhardt's forecast is somewhat less optimistic, showing only modest 0.3% growth in 2006 and 0.7% in 2007. Over the 2005-2008 period, Denhardt expects gas demand will grow an average of 1.6% per year. He expects LNG imports to grow 21.9% per year over that period.

However, Denhardt notes that it is very unclear what impact rising production and LNG imports under long-term contracts will have on LNG spot cargoes. Most of the LNG currently being imported into the U.S. is on a short-term or spot basis. "A major uncertainty is the price level required for the U.S. to continue to receive this supply," said Denhardt, noting that LNG prices in both Europe and Asia are linked to oil prices.

"The LNG question is big," he said. "If we get the 1.2 Bcf/d (new liquefaction in Nigeria and Trinidad) of additional supply, and we don't lose any spot LNG, that's a lot of additional supply coming into this country." It's bound to pressure prices lower "unless you need to have a high price to get the LNG to flow."

Denhardt predicts Henry Hub prices will average $6.57/MMBtu this year, but he's hesitant to even put a 2006 price forecast out there. The current 2006 futures strip is about $7.18.

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