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Bullish Deutsche Bank Sees 'Structural Shift' in Gas Market

Bullish Deutsche Bank Sees 'Structural Shift' in Gas Market

Natural gas industry analysts at Deutsche Bank have concluded that a "structural shift" has occurred in the supply and demand underlying the gas market, setting the stage for gas prices to hold their current ground at more than $2.50 for the next two years.

"In our view, the old trading range of $2.00-$2.50/MMBtu has been supplanted by a new $2.50-$3.00 range for wellhead prices," the group said in a report last week.

The group raised its wellhead price forecast to $2.75/MMBtu for 2000 and 2001 from $2.35 and $2.50, respectively. It forecasts Nymex futures to average $2.90 in both years, up from prior forecasts of $2.50 for 2000 and $2.65 in 2001.

As evidence of the "shift," Deutsche Bank notes that despite the warmest winter on record and a dip in oil prices, gas futures prices are trading above $3 on the New York Mercantile Exchange (Nymex). "We attribute this strength to a growing recognition that domestic demand is likely to outstrip supply, leading to both lower storage and the need for higher import levels --- and higher prices in 2000."

On the demand side, the group notes that industrial production is picking up, power demand is growing and gas is the fuel of choice for new generation. Deutsche Bank projects demand will increase 3.8% to 22.2 Tcf this year and an additional 2.6% to 22.8 Tcf in 2001, which is up significantly from the 1% growth in 1999. After declining slightly in 1999, industrial gas use is expected to climb 4.6% in 2000 and 3% in 2001. Electric utility consumption is forecast to grow 5.4% this year and 2% in 2001 despite its 4% drop last year. Residential demand is expected to slide some this year because of the warm first quarter but should rebound with 2.5% growth next year, the group predicted.

Meanwhile, despite higher capital spending, domestic gas production is not keeping pace and probably will continue to struggle this year and next. Deutsche Bank analysts said they expect domestic supply to rise by less than 0.2 Tcf to 18.85 Tcf this year after flat production in 1999. "The increase in gas prices, which started in 2Q99, has resulted in a rise in gas drilling, but the types of wells being completed are tending toward shallow, onshore locations, which are not as productive as the deep-water offshore areas," the group said. "Drilling budgets for the larger companies, which have stayed relatively modest so far this year, could result in lower production than would otherwise be expected." It estimates Gulf production will rise significantly from 5.8 Tcf in 1999 to 6 Tcf this year and 6.2 Tcf in 2001. Output from the rest of the U.S. in total, however, is expected to continue shrinking from about 13 Tcf in 1998 to 12.8 Tcf in 2000 and 12.7 Tcf in 2001.

Furthermore, storage levels are near normal and are expected to be "quite low by the start of the upcoming winter" because of demand growth and supply constraints. The group projects storage will reach only 2,650 Bcf by the start of next winter.

Imports from Canada are "unlikely to be able to fill the gap." Many of the wells being drilled are shallow wells with high depletion rates.

The group admitted its own projections were more bullish than others on Wall Street were. It said the "First Call mean," or the current consensus of Wall Street analysts, is that wellhead prices will average $2.55 this year and $2.50 in 2001. Rocco Canonica

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