The Henry Hub natural gas spot price is expected to rise to $5.48/Mcf in 2010 because of the “current decline in drilling activity and projected growth in consumption next year,” the Energy Information Administration (EIA) said in its Short-Term Energy Outlook for August.

And “sustained cutbacks in drilling activity or stronger demand than expected could lead to even higher prices,” the agency said in the outlook, which was released last Tuesday.

The EIA sees production falling at a faster clip in the months ahead. “Data for March through May suggest that the decline in drilling has begun to reduce marketed production in the Lower 48, non-Gulf of Mexico [GOM] region. While the monthly average rate of decline was [only] about 0.3 Bcf/d during those three months, production is expected to decrease at a faster pace through the remainder of [the year] with some curtailments from existing production expected.” At the same time the EIA expects demand to rise by 0.5% to 62.09 Bcf/d in 2010 after tumbling 2.6% to 61.76 Bcf/d this year.

U.S. drilling activity is likely to pick up early next year, but the lagged affect of reduced drilling this year is expected to lead to lower production in all regions outside of Alaska, the agency said. It estimates that production will fall to 56.98 Bcf/d in 2010 from 58.65 Bcf/d this year.

The spot price averaged $3.50/Mcf in July, 41 cents below the average spot price in June. “Prices remain low as the drop in drilling activity thus far has failed to bring about the producing decline necessary to slow the natural gas inventory build,” the EIA said. It expects spot gas prices to average $3.92/Mcf this year.

In the meantime storage levels are headed toward a record high and more foreign supplies potentially will make their way to U.S. markets, which “suggests that prices may fall below current projections before space heating demand picks up this winter and economic conditions improve,” the agency said.

Working natural gas in storage was 3,089 Bcf at the end of July, 496 Bcf above the five-year average and 580 Bcf above the level during the same period in 2008. Working gas stocks eclipsed the 3,000 Bcf level on July 24. “This is the earliest day on record that inventories have exceeded 3,000 Bcf during the injection season (April through October),” the EIA said. The previous record was set on Aug. 31, 2007 when working gas stocks reached 3,005 Bcf.

“We now expect working natural gas stocks to reach 3,800 Bcf at the end of October, 235 Bcf above the previous record of 3,565 reported at the end of October 2007,” the agency said.

The GOM appears to be the one bright spot in terms of production. The EIA sees federal GOM production increasing by 3.3% to 6.62 Bcf/d “in part because recovery from damage sustained during last year’s hurricane season and the lower incidence of hurricane activity this year.”

While U.S. producers try to cut back production in response to low prices, the EIA said it expects more LNG imports from Europe and pipeline imports from Canada to be headed here. “With limited natural gas storage availability, recent data suggest that European inventory levels are now nearing capacity. As a result, LNG shipments may be redirected to U.S. ports in the coming months as prices in the European market become less attractive to LNG suppliers. A similar scenario may also occur in Canada, with natural gas pipeline imports increasing in the months ahead as Canadian storage facilities are topped off.”

The EIA projects LNG imports will increase to about 500 Bcf this year, up from 352 Bcf in 2008, and rise to about 740 Bcf in 2010.

With respect to gas demand, “the severe contractions during the first half of the year contributed to an estimated 3.8% decline [to 61.76 Bcf/d] in daily average natural gas consumption compared with consumption during the first half of 2008. The decline in natural gas use during this period was driven principally by a drop in industrial activity, reflected in the 17% year-over-year decline in the natural gas-weighted industrial production index during the first half of the year,” the EIA noted.

Because gas prices have slipped to the point where they now compete against coal for a share of baseload power generation, “natural gas consumption in the electric power sector is expected to increase by 2%” to 18.56 Bcf/d this year, according to the EIA. This is more than the industrials’ share of gas consumption (16.52 Bcf/d) and residential customers’ share (13.04 Bcf/d).

Both natural gas and renewable fuels are nipping into King Coal’s share of the U.S. power generation market, according to the EIA. “Our projected electric power sector consumption of about 975 million short tons of coal in 2009 would be the first time since 2002 that annual consumption falls below the billion short ton level. The 6.4% decline [from 1,041.6 million short tons in 2008] in coal consumption in the electric power sector is the result of lower electricity generation combined with projected increases in generation from natural gas, hydroelectric and wind,” the agency said.

“Coal consumption in the electric power sector is expected to increase by 1.3% [to 987.2 million short tons] in 2010, but remain below the billion short ton level,” the agency said. The EIA sees coal regaining a larger share of the baseload generation mix in 2010 as “rising natural gas prices hinder growth in natural gas-fired generation.”

The EIA expects electricity sales in the industrial sector to nose-dive this year by 10% to 2.41 billion kWh/d from 2.68 billion kWh/d in 2008, and to slip even further in 2010 to 2.40 billion kWh/d. The projected drop in retail electricity sales this year will be less sharp — by 2.7% to 9.90 billion kWh/d from 10.17 billion kWh/d last year.

The EIA said its sees total electricity sales falling to 10.28 billion kWh/d this year from 10.58 billion kWh/d in 2008. It anticipates overall sales rising slightly to 10.37 billion kWh/d in 2010.

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