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Analysts Cut Price Forecasts on Storage Surplus

Spring and summer gas prices will have to remain in the $6/MMBtu area (Henry Hub) or lower to rebuild industrial demand, stimulate gas-fired power generation (whose main competitor is now coal rather than residual fuel oil) and deter liquefied natural gas (LNG) imports, said Credit Suisse analyst Carl Kirst in a research note last Wednesday.

Kirst's price forecast falls well short of current Wall Street consensus and is even lower than some recent predictions from several prominent industry consultants. The injection season futures strip (April through October) as of the close of trading last Thursday was $7.672.

Kirst lowered his 2006 gas price forecast last week to $7.25/MMBtu based on the current gas storage surplus. Working gas levels in storage are 60.1% above the five-year average. "In short the key driver behind lower expected prices is the industry's need to work off excess gas in storage," Kirst said.

"While conventional wisdom generally points to continued near-term gas price weakness, we would note that this revised outlook is now 15% below consensus for full year 2006 ($8.50 FirstCall) with a fourth quarter average of $7.00, 22% below the Nymex 4Q06 average of $9.04 today."

Credit Suisse's revised forecast follows recent downward revisions by Raymond James & Associates and several industry consultants. Late last month, Raymond James cut its price forecasts to $7 for the second quarter, $7.50 for the third quarter, $7.75 for the fourth quarter and $7.81 for the year. However, Raymond James said it expects the crude oil-to-gas price ratio to eventually return to 6:1, which would push gas prices considerably higher -- about $10.42 given today's near month crude futures. The Raymond James forecast for 2007 stands at $10/MMBtu.

Credit Suisse's longer term outlook is much more conservative. Nevertheless, a recent industrywide analysis of E&P costs by Credit Suisse found that the marginal cost of supply in the United States (shale and tight sands) is about $5.94/MMBtu given a 10% after tax rate of return. "This in turn implies that sustained gas prices below $6 would quickly translate to reduced drilling activity and a swift supply-induced correction, especially when considering that the more expensive nonconventional resources being drilled at the margin have extremely high first year decline rates (some of which are in excess of 50%)."

Industry consultant Stephen Smith of Stephen Smith & Associates said last week that summer gas prices probably won't dip much below $6 because of the current relationship with the prices of competing fuels. Likewise, energy consultant Ron Denhardt of Strategic Energy and Economic Research predicts prices will remain above $6.50 during the injection season and rise into the $7.00-7.50 range for the summer. However, as is usually the case with energy costs, in the end the weather will tell the story.

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