With prices remaining high and conventional supply sources drying up, U.S. producers are finding themselves in a tough situation, where a tightening supply crisis might force prices even higher in the next few years, according to Jim Duncan, director of structured products for ConocoPhillips Gas & Power.

“The reality of this marketplace is that the perception of this market is going to drive the price, and that is a hard thing to grasp because it is not mathematical. I am not concerned at all about supply starting about 10 years from now… I am extremely concerned about the short-term supply in the natural gas market,” Duncan said at the LDC Forum in Chicago last week.

He said the current situation shows that 60-70% of gas supply to the North American continent is produced by small and medium sized independent drillers, which continue to drill the same declining plays. “There’s no new gas,” he said. “There are no new big finds. We are sticking the holes into the same bag of gas, which only drains the bag of gas faster. It’s not hard to see that if we drain the gas out of the same formations, eventually, that productivity will go down.”

Adding to the short-term supply problem is the expense. From talking to a number of these producers on a regular basis, Duncan said the response he keeps getting is “we can’t afford it, each well costs approximately $1 million.”

“One year ago, these people were drilling 10 wells, where they are drilling one well this year,” he said.

Looking at new supply sources, Duncan listed the usual suspects, such as the currently off-limit areas of ANWR, the Mackenzie Delta, the eastern Gulf of Mexico and the East Coast. He also said increased coalbed methane, LNG and increased Canadian imports are necessary.

To solve the near-term domestic supply crunch, Steve Becker, vice president of TransCanada’s gas development east unit, said the United States must rely on LNG for the next four winters and focus on new build pipelines from the Arctic in the long term. To build such expensive projects (Mackenzie $2 billion; Alaskan line $15-20 billion), Becker said pipelines and producers need:

As for supply this coming winter, storage should rebound to the 3 Tcf “full” level by the end of the fill season without problem due to demand destruction, according to Fred Hunzeker, president of Tenaska Marketing Ventures.

Speaking at the forum, Hunzeker said “3 Tcf is not going to be a problem, I even think we are going to get back to 3.1 Tcf before it is all done.” He also noted the uncertainty involved relating to rumors currently swirling around the industry that allege the EIA’s current storage numbers might be understated by 50-150 Bcf.

Hunzeker said that high prices, high demand and high volatility this summer led to approximately 2-4.7 Bcf/d in demand destruction, coming mostly from the chemical industry. “Consensus among the analysts is that we are going to be down about 3-5% total demand in the U.S. this year, so prices have shown a response that the market is elastic,” he said.

Borrowing a quote from a Lehman Brothers’ analyst in April, Hunzeker said, “The key determinant of U.S. natural gas prices has become the price that customers can bear, rather than the price that producers need to earn a return.”

As for LNG coming to the rescue, Hunzeker said by 2007 it might be making up about 10% of the gas in the U.S. marketplace.

Stating that the current high prices are “not a bad dream,” Hunzeker said we are now “in a world of volatility. It is here to live with and manage.” He warned that the worst thing the industry can do is to crawl in a foxhole and hide. “If we take assets off of the marketplace, all we are going to do is increase the volatility and increase the costs of these products. The companies that respond and actively manage their risk and volatility, are going to profit from this environment. The companies that don’t, that crawl in the hole, are the ones that will suffer the pain.”

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