Because of its maturity and growth, North America’s exploration and production (E&P) sector is less likely to respond as quickly as in the past when there were unsustainable commodity prices, and thus, the industry will trend toward less activity directed at short-term production maximization, according to analysts with RBC Capital Markets.

And because of that maturity, gas production will erode more than expected, while natural gas prices will be higher than expected.

“Over time, we expect markets will be willing to discount higher natural gas prices. as the level of sustainable price migrates higher to accommodate more non-conventional production,” said the group, led by analyst Joseph D. Allman. “Constrained activity will also allow for a more attractive cost structure.”

RBC noted that as the gas industry becomes a “source of higher returns.” E&Ps may be forced to look for new production “further afield in international operations. At the same time, other sources of non-conventional production growth will be expanded.” Still, they said, “we remain very upbeat about the prospects for the oil and gas industry. Stronger financial discipline, good demand growth and the prospect of a strong natural gas market in North America all suggest that profitability should remain high, in our assessment.”

In 2000-2001, the experience “demonstrated that the unfettered pursuit of increasingly marginal prospects fails to deliver meaningful growth, yet erodes rates through higher oilfield service costs,” and that aspect “continues to weigh heavily on E&P managements.” So far this year, RBC analysts said that the independents now are pursuing fewer, but larger projects. “We think this relative inactivity will likely result in more profitable production growth going forward, as higher impact frontier and international development projects result from today’s intensive exploration efforts.”

However, as E&Ps look for larger prospects, many have returned to exploration, which is particularly apparent in the U.S. Gulf of Mexico, “where rig activity is well off from previous levels and is much lower than most would have expected given the recovery in natural gas prices,” said analysts. “Lack of activity, shifting focus and increased discipline of large producers suggests the decline in U.S. production will continue and up to 5 Bcf/d (9%) could evaporate before new activity stabilizes production.”

RBC noted that already this year, a 3.5% decline took place in the first six months, and “trends for 3Q 2002 suggest further declines.” Even though gas prices have had to compete with crude-related prices, “there is some potential for natural gas to be priced above crude oil for an extended period, rationing demand and establishing natural gas as the premium price fuel that it arguably should be.” That said, RBC analysts said they are looking at an “upward bias” in their Henry Hub forecast at $3.50/Mcf by the fourth quarter and going forward.

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