Weather normalized gas demand this winter has exceeded gas supply by about 750 MMcf/d on average, according to a Monthly Energy Outlook by Stephen Smith Energy Associates. This gas shortage means that gas prices will have to remain at “demand destruction” levels ($4-$7 at the Henry Hub) this summer in order for storage to be refilled to an adequate level by next fall, the consulting firm said.

“The persistent slippage in domestic gas production capacity is the critical element in what has become a chronic shortage environment, and other than an improbable series of freakishly mild winters we see no quick fix for this situation.” Stephen Smith predicts gas prices will average $5.10 this year at the Henry Hub.

Based on production data from the state of Texas and Louisiana and producer surveys, Stephen Smith concludes that gas production is down about 4.7-6.0%. “The annualized sequential production decline for the last six quarters has averaged about 6%,” according to producer filings with the Securities and Exchange Commission.

“Some of the majors had some very large gas reservoirs that were being drawn down over the last few years. Also an increasing share of drilling is being directed to regions that tend to have a much smaller share of total reserves that are produced in the first year,” Stephen Smith said. “So it is possible that the decline rate might ease somewhat going forward. But the basic conclusion remains: a drilling boom driven by two years of $4+ prices could not reverse, on a sustained basis, the trend decline in domestic gas production. The end result was that market balance was achieved by gas prices that were sufficiently high to destroy the most price elastic demand.”

Stephen Smith also predicts Canadian imports will drop 5% this year. “Lower 48 and Canadian production appears to be locked in a decline that will not be reversed at even $4 gas,” the firm said. LNG will make up for a very small portion of the lost supply, and increasing LNG imports will bring a new factor into the domestic market: a linkage between North American markets and international LNG supply and demand. “Now a surge in Asian demand or a sudden weakness can have a non-trivial influence on North American gas markets.”

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