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Modest Recovery -- Maybe -- By Late '09 for Prices, Demand

A recovery for natural gas prices in 2009 is unlikely, but as the rig count declines, it should set up supply to drop substantially at the same time the economy begins to recover, which bodes well for a more bullish 2010, energy analysts said last week.

Raymond James & Associates Inc. analysts J. Marshall Adkins, Wayne Andrews and Kristal Choy predicted that gas prices could average $8/Mcf by 2010, well above their forecast of $5 for this year. The analysts said it was difficult to look ahead without considering how much the exploration and production (E&P) and oilservice indices were hammered in the last half of 2008 (see related story).

"The S&P 500 decreased 39% in 2008, and the decline in oil and gas prices meant that E&P and oilservice indices declined significantly as well (38% and 60%, respectively), despite their hefty gains during the first half of the year," said Adkins and his colleagues. "This followed tremendous outperformance in 2007, with the indices up 42% and 51%. Likewise, alternative energy and coal stocks fell 70% and 63%, respectively, in 2008."

As bears, Raymond James' energy analysts were in the minority on forecasting lower U.S. gas prices early last year, as gas prices rose, liquefied natural gas imports stalled, cold weather cut into storage and the deepwater Independence Hub gas platform was shut in for an extended period. Still, even with their early bearish call on prices, "our 2008 gas forecast of $6.50/Mcf was too low by nearly 30%," Adkins noted.

By mid-year 2008, the downturn in the gas market appeared to reflect the analysts' concerns. Then came the market meltdown, which pressured demand.

"On the North American gas side, we believe that the weakened demand outlook, on top of continued supply growth through the first half of 2009, will keep gas prices depressed through most of the year, bottoming in 3Q2009," said the Raymond James team. "As a result, our 2009 price forecast is $5/Mcf, which would be the lowest since 2002. While U.S. gas prices should remain weak through 2009, the massive decline in the rig count should eventually help balance the market," which in turn should lead gas prices as much as $3 higher.

Analyst John Gerdes and his colleagues at SunTrust Robinson Humphrey/the Gerdes Group (STRH) are somewhat more optimistic on prices and recovery. They expect economic contraction to "modestly" erode U.S. gas demand this year. In a report issued Friday, STRH forecast a 2% contraction in U.S. economic activity in 2009, which "implies U.S. industrial gas demand should decline +0.5 Bcf/d (3%), and gas-fired power generation should exhibit no growth on average this year."

U.S. industrial gas demand is currently running more than 1 Bcf/d lower year/year (y/y), and gas-fired power generation demand is running more than 1.5 Bcf/d lower y/y, "which should persist through the first quarter, and improve over the remainder of the year..." STRH analysts said. On average, the 1 Bcf/d-plus of lower gas-fired power demand because of the weak economy "should be offset" by the 1 Bcf/d-plus of higher gas-fired power demand, assuming normal cooling season conditions.

"Notably, our anticipated improvement in industrial/power generation gas demand as this year progresses is predicated on a $5.50 gas price forecast the first half of the year and a $6.50 gas price the second half of the year," Gerdes said. "An average $6 gas price in '09 appears necessary to lower U.S. drilling activity and production sufficiently to reestablish market equilibrium, while aligning E&P capital spending with cash generation."

This year, a one-third reduction in drilling activity (1,000 average gas rig count) "appears necessary to align E&P capital spending with cash generation, assuming a $6 average gas price, and lower production sufficiently to rebalance the market, given a 20% increase in well productivity," said Gerdes. "Interestingly, overall U.S. industrial gas demand was modestly positive last year even with $10-plus gas prices earlier in the year and acute economic weakness later in the year."

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