UBS Warburg natural gas analyst Ronald J. Barone said he has lowered his gas price forecast for this year to $5.50/MMBtu at the Henry Hub from about $5.85, but will maintain his projections for next year and 2005 at $4.65 and $4.15, respectively, mainly because wellhead decline rates continue to accelerate while demand from the residential, commercial and power generation sectors continue to increase.

The Wall Street consensus on prices this year is about 12 cents higher (Henry Hub equivalent) than Barone’s new forecast, but the Street is slightly lower than his 2004 projection.

“Since our last forecast adjustment [in May], several factors have combined to loosen the overall North American natural gas supply/demand balance and ultimately place downward pressure on our full-year 2003 forecast,” Barone said in a note to clients. “With spot prices currently trading near $4.90/MMBtu and storage now on track to reach the 3,000 Bcf ‘comfort’ level by Nov. 1, we are compelled to lower our ‘out of the money’ monthly projections for the balance of 2003.”

He noted that with prices averaging near $6/MMBtu at the Henry Hub during the first half of the year, a significant amount of demand destruction occurred. “Industrial demand destruction was evident in the fertilizer, chemical and metals industries as well as power generators with alternate fuel switching capacity.

“Beyond industrial demand destruction, high natural gas prices have curtailed [natural gas liquids] stripping.” UBS estimates that during the first half of the year, NGL field production was down about 9.8% from the first half of 2002 when gas prices were significantly lower. “Consequently, lower [first half 2003] NGL production levels effectively increased natural gas supply available for storage.”

As a result of lower demand and increased supply because of less NGL production, storage is now in much better shape than at the time of Barone’s previous gas price forecast in May, he said. “To get [storage levels] to 3,000 Bcf by Nov. 1 the industry will require an injection pace of 9.5 Bcf/d versus the 11.2 Bcf/d average rate during the current injection season to date. By comparison, injection rates averaged 6.3 Bcf/d in 2002 and 8.3 Bcf/d over the past nine years.”

If storage injections average the 8.3 Bcf/d nine-year rate through the end of the injection season, storage levels will rise to 2,905 Bcf on Nov. 1, versus a nine-year average level of 3,008 Bcf on that date. If storage continues to rise at the pace it has averaged so far this injection season, there will be 3,128 Bcf of gas in storage on Nov. 1. “If storage balances ultimately fall within this rough calculation range, we believe the industry will be in reasonable shape to start the 2003/04 winter heating season — even if the economy continues to improve,” said Barone.

However, he doubts that gas prices will “collapse.” Wellhead decline rates continue to accelerate. UBS estimates that first year decline rates on average U.S. producing wells have increased to 28% from 25% in 2000 and 23% in 1998. “Moreover, our E&P team continues to call for a 2.1% decline in 2003 lower 48 production (to 49.3 Bcf/d) on the heels of an estimated 6.9% decline in 2002.” UBS expects a 2.1% production decline in Canada this year.

Although the rig count continues to grow, UBS maintains that reserve additions per rig continue to decline, and the lag time for production from new rigs will delay any production impact by 12-18 months.

Furthermore, gas remains the fuel of choice for homes, commercial uses and power generation. Although some industrial demand may be lost permanently because of high gas prices, demand from other sectors still will lead to a net increase in demand of 1-2% over the next several years, according to Barone.

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