While many industry consultants and analysts are predicting that gas prices will escalate to more than $7/MMBtu as soon as this winter and will hold at that level through next year (see Daily GPI, July 22), Massachusetts-based Energy Security Analysis Inc. (ESAI) believes the market is underestimating the substantial impact from increasing imports of liquefied natural gas (LNG) and will be in for quite a surprise near the end of the storage injection season.

As a result mainly of rising LNG imports, ESAI is forecasting that gas prices will fall and remain below $6 through 2014. In fact, ESAI continues to call for significantly lower natural gas prices over the next few years due to surging LNG imports and slowly climbing U.S. production levels.

“While we are closely monitoring the decreasing rig efficiencies and increasing supply cost structures, demand growth will be low to moderate at best until 2008-allowing new sources of supply to effectively re-balance the market over the near-term,” according to ESAI Senior Energy Analyst Scott DePasquale. “As we warned in our last quarterly report, LNG imports are starting to materially impact the cash markets in both the Gulf and Northeast regions-acting as a catalyst to regional storage injections, and helping to dampen the impact of price pressures on the Nymex. We expect that trend to continue for the next three years.”

First quarter LNG imports were up 50% to 150 Bcf from 1Q2003 levels when LNG import terminals were operating at only 50% of capacity. For the second quarter of 2004, ESAI expects LNG imports to total 205 Bcf. LNG imports for the year are expected to total 800 Bcf compared to only 506 Bcf in 2003 and ESAI is forecasting that LNG will rise to 1 Tcf in 2005 and 1.7 Tcf by 2008.

ESAI believes that the infusion of all this new supply will cause significant downside price pressure over the next few years — bringing natural gas for delivery at the Henry Hub to an average yearly low of $4.29/MMBtu in 2008.

“We are currently at the beginning of a short-term production growth phase, and the associated E&P activity is likely to carry the market well into early next year,” said DePasquale.

Despite this influx of new LNG supply and the rise in domestic production, however, gas prices shot back over $6/MMBtu Thursday in response to a slightly lower than expected storage injection number and are poised to continue rising. Someone at Nymex clearly isn’t getting the message. DePasquale blames the non-commercials, the speculators in the market, for being ignorant of these supply changes.

Non-commercials operate differently than their commercial counterparts, and because of their growing influence in the futures market, their impact on prices is far more evident now than at any time in the past.

“The first reason [prices are so high], I would suggest, is the increase in open interest in natural gas [futures] by non-commercials,” said DePasquale in an interview with NGI. “In the late 1990s and early 2000s, open interest by hedge funds and non commercial players never breached 12-13%. If you looked at it a few weeks ago, open interest [by non commercials] peaked — when we had that second spike above $6.50 — to roughly 32%. It’s huge, I assure you. They’ve actually been sustaining levels of open interest above 25% since just after March.”

The entrance of more speculative traders in the market more closely links natural gas to the crude oil and petroleum products markets because the financial players trade gas in a basket with the other energy commodities, according to DePasquale. “I think that has a lot to do with why we are sustaining higher prices but it’s not [the entire reason].”

He also noted that the financial players don’t have a clear understanding of the current and future gas supply situation. That’s partly their own fault, but it’s also the fault of industry companies, regulators and the federal government. There’s a dearth of timely supply information available. What is available is several months old or provides an incomplete picture of the total supply situation. There also have been reserves accounting errors which has led to even more confusion about future supply.

But the financial players should be getting more of the message about growing supply relatively soon, said DePasquale. “They will start to see larger deviations between the futures market and the actual cash prices at the various hubs,” he said. “When cash stops reacting to the Nymex and it becomes very competitive to try and dump all this supply into the market in the Gulf, you will start to see the futures come in line with cash.

“Williams and Enron, who really understood the cash markets, are no longer in the game, so folks have been taking cash prices that they may not have taken in other periods. But I can assure you, as production becomes more robust toward September and we don’t have as much of a need to put gas into storage because storage levels are already full and the LNG imports are coming in, if you are a cash trader and everybody is calling you to buy gas, you aren’t going to care anymore about the Nymex. It’s not going to happen until storage is almost full.” But that could end up taking place a month early this year, he said.

However, ESAI also warned that finding and development challenges are likely to catch up with the market by late 2005, at which time ESAI expects a significant lull in U.S. dry gas production. “In fact, we warn that over the long-term, domestic resources will continue to diminish, increasing the costs associated with finding and development, and increasing the need to rely more heavily on LNG imports to fill the gap in a cost effective manner,” DePasquale said.

Nevertheless, the Boston based energy research firm remains confident that further investments in the domestic LNG infrastructure, if permitted, will indeed help to keep prices under control.

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