Holding out little hope that the tight domestic natural gas supply situation will ease this year, a top producer official last week said between 4.5-7 Bcf/d of demand will need to be pushed out of the market through higher prices in the months ahead in order for the industry to have sufficient gas inventories for the 2003-04 heating season.

“We have no choice in the short run” other than to resort to demand destruction in the market, said Richard J. Sharples, senior vice president of Anadarko Petroleum Corp., at the NGI-sponsored GasMart/Power 2003 in New Orleans last Tuesday. “We have been saying this since 1998… Because of the artificial limitations that have been placed on our resource base, we don’t have the ability to grow the market.”

He estimated about 3.5-6 Bcf/d more gas will have to be injected into storage this year than in 2002 just to approach the historical range, and that production this year will be more than 1 Bcf/d below the year-ago level. This means that up to 7 Bcf/d of supply will be unavailable to the market throughout most of 2003, and will require a like amount of demand to be destroyed, said Sharples. Taking out this amount of demand from the market won’t be easy since the “most vulnerable demand” disappeared during the previous price spike, he noted.

Even with aggressive storage injections this year, Sharples said he expects gas storage levels to only reach 2.7-2.8 Tcf by next Nov. 1, shy of the traditional target of 3 Tcf. “I used to say 3 [Tcf], but now I’m not as optimistic.” Gas storage needs to return to 3 Tcf to achieve “some semblance of comfort.”

Sharples, a long term veteran of the natural gas market, often viewed as one of the more optimistic prognosticators in the industry, painted a very grim forecast for energy executives. Beyond this year, there “may be a few bright spots for supply in ’04, but we’re still going to be constrained… And beyond 2005, we’re going to be constrained significantly by supply,” he told NGI.

“It hurts me to have to bring this message to you. But we made this bed and we’re going to have to lie in it.” He said the legislative fixes being proposed by Congress, such as royalty relief, are “‘Band-Aids’ that will have virtually no effect” on expanding domestic gas supply. These “may look good for people running for re-election, but it’s not going to fix the problem.” What producers need is more access to public lands for drilling, he noted.

“We as an industry…need to speak with one voice in Washington, and say that the price that we’re paying for restricted areas of exploration is too high.” There’s been a lot of talk on Capitol Hill about subsidies to build an Alaskan gas pipeline, increased Rockies’ exploration and opening up the Arctic National Wildlife Refuge (ANWR), but he said there’s been “virtually no action.” He questioned whether any of these efforts could succeed given the strength of the environmental lobby which would be just as happy if the oil and gas industry went away.

To offset the tight supply situation, Sharples estimated about 1-2 Bcf/d of demand could be pulled out of the market this year through fuel-switching to distillates; up to 1 Bcf/d could be saved “just by resetting thermostats;” up to 1 Bcf/d from temporary plant closings; possibly another 1 Bcf as a result of industrial demand destruction; and between 0.3-0.5 Bcf/d could be squeezed from power generation. These portions of the market will be discouraged by higher prices and increased volatility. The gas market “would be lucky” to get that much demand destruction from power generators, said Sharples, adding that his estimate of 0.3-0.5 Bcf/d may be “overly optimistic.”

Most of the gas use that can be substituted by high-value distillate is going to have to be switched, but there will be a cost to the economy. Distillate storage is also near all-time lows, so the additional 250,000 barrels needed to replace natural gas will boost distillate prices as well. Sharples did the math: over the last three years the spread between distillate and crude oil has averaged $5. “I think we’re going to add $1 to $3, maybe $4 barrel to that spread….so you take that $5, make it $6 to $8, add that to a $25 crude price, and that’s a $5-$7 gas price.” It will take a $5 gas price and spikes to $7 to offload the gas demand onto distillate.

Since distillate is essentially diesel fuel and “virtually every product in this country is moved by a truck or train powered by diesel fuel, this will have a significant inflationary effect across the economy.”

He said he is “upset” when workers lose jobs due to plant closings brought on by high gas prices. But “I say ‘thank goodness'” as well because “we can’t balance this market unless we make some demand go away.”

A number of ammonia producers shut down for a period last year, but they have since returned to natural gas as ammonia prices have risen. They will have to drop off again, and probably they should look at the long term. “There are a number of places in the world where they can get gas for between $1 and $2,” he said, advising that they move operations out of the U.S. Sharples also questioned how much of the high-priced gas market the chemical industry would tolerate before it moves permanently overseas.

On top of the decline in U.S. production, net gas imports began to fall in 2002 and are continuing to decline steadily, he noted. Sharples believes liquefied natural gas (LNG) will pick up part of the slack, but he said it won’t be enough to offset the decline from Canada. He estimated the U.S. needs to find more than 12 Bcf/d this year just to make up for the decline. In fact, the U.S. needs to discover a new Canada each year.

The industry “can fix this [supply] problem…But we can’t fix it without exploring” in the less-mature regions of the Gulf of Mexico, western U.S. states and in eastern Canada, according to Sharples.

In these areas, he noted drilling requires longer lead times, higher infrastructure costs and, in some cases, is limited to only certain seasons of the year. It takes 2-10 times longer to bring gas on line in new developing areas. But “industry [is] not exploring, not willing to take the risks” at this time. Industry-wide, he noted the capital spent on exploration has shrunk from 25 cents on each $1 to 8 cents on each $1. Meanwhile, there has been a “big surge” in acquisitions, which has not added anything to producers’ reserve positions, Sharples said.

“We continue to drill at a relatively reasonable pace [in the traditional basins], but we can’t keep pace with the declines.” Since 1999, Sharples noted the average well drilled in the United States has lost half of its initial production rate, while its decline rate has doubled.

Drilling requires big capital, and this industry “is not a very stylish place” for investors now, said Edward Kelly, head of North American Gas & Power for Wood Mackenzie. Like Sharples, he forecasts a bleak supply scenario in the years ahead, although he suggested the real crunch will hit in 2004-2005 and beyond.

“When we look at 2010, not only is 30 Tcf not possible, the market’s barely bigger than it is right now,” he told executives. A more likely estimate, he believes, is 25 Tcf.

On the pricing front, Kelly said he expects gas prices to remain in the upper $4, lower $5 range over the next two years. Sharples said the market still is on the upside of a long commodity cycle that began in 1994. Prices will come down, he noted, but not in the short run.

Kelly and Sharples also indicated that some producers, utilities and banks are stepping into the role of marketer, which was left largely vacant when traders exited in the wake of scandals. “It’s going to take time” to fill this void in the market, Sharples noted.

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