Even normally bullish energy analysts last week turned bearish on the short-term outlook for natural gas prices, with many now believing gas prices will remain low until some of the excess storage capacity is removed.

The Raymond James energy team, which usually leads the pack on forecasting strong gas prices, last week reduced its 4Q2006 natural gas price forecast by $2, to $5.75/Mcf from $7.75, based on the “significant bearish shift” in gas storage injections.

According to Raymond James energy analyst J. Marshall Adkins, the strong storage injections on a weather-adjusted basis suggest the U.S. gas supply/demand equation “has miraculously changed from being 2 Bcf/d tighter versus last year to suddenly 3 Bcf/d looser versus last year. In other words, these recent storage injections suggest that either gas demand has fallen by up to 5 Bcf/d and/or gas supply has increased by up to 5 Bcf/d just in the past few weeks.”

The large injections, said Adkins, “have clearly created a much more bearish short-term outlook for natural gas prices…Given our view of limited gas storage capacity, it now appears that localized market ‘gas on gas’ competition may depress U.S. natural gas prices for at least the next few months until a lot of the surplus spot gas is mopped up (or helped by involuntary production curtailment at the wellhead due to higher pipeline pressures).”

Raymond James also reduced its 4Q2006 oil forecast to $62/bbl from $68 based on the recent drop in oil prices. It is estimating 2007 oil prices will be around $70/bbl.

“For us, the key to 2007 natural gas prices will be exactly how much gas we can actually store this summer,” said Adkins. “If maximum storage is 3.5 Tcf, then 2007 gas prices are likely to trend back toward $10/Mcf. If storage capacity is closer to 3.8 Tcf, then 2007 gas prices will look much uglier than we are currently forecasting. Unfortunately, it does not appear that anyone really has a clue about the actual maximum capacity limitations of U.S. natural gas storage.”

Adkins noted storage capacity estimates by the experts range from a low of 3,400 Bcf to a high of 4,000 Bcf. To better understand “true” summer-ending storage capacity, Adkins considered different methodologies used by the EIA and set an estimate for storage capacity at 3,500 Bcf.

“While we recognize the potential for error in estimating actual gas storage capacities, we think it makes more sense to rely upon actual gas storage peaks rather than theoretical peaks,” said Adkins. “The 3,367 Bcf noncoincidental regional peaks achieved in 2004 and 2005 are probably the best place to start. If we add a 50 to 150 Bcf ‘fudge factor’ to these actuals, then storage capacity would stand at around 3,450 Bcf to 3,500 Bcf. The fudge factor would account for 1) the unprecedented financial incentive to store gas (or the price contango between the near month and winter month gas contracts), and 2) the fact that some salt dome storage capacity has been added over the past few years. Accordingly, our best guess at full storage capacity is around 3,500 Bcf.”

Adkins said the “ending-summer gas storage level attained at Oct. 31 will have a defining effect on the winter-ending storage level in April of 2007. Simply put, if maximum storage capacity turns out to be 3.5 Tcf (assuming normal winter weather), we project that the market will start the next summer injection season with 1.3 Tcf.

“While our estimate of 1.3 Tcf of winter ending storage is higher than the long-term average of almost 1.2 Tcf, it would be meaningfully lower than the 1.7 Tcf where we ended last season. Given that 1.3 Tcf would be well below recent seasonal highs, gas prices would likely work their way back toward a 7:1 or 8:1 ratio with crude prices. In other words, we think the gas market would be tight enough to support natural gas prices back up into the $8 to $12 per Mcf range (assuming crude averages around $70 per barrel).”

However, if maximum capacity is 3.7-4.0 Tcf, “we would then have to concede that average gas prices in 2007 would be significantly lower than our current estimates.”

In a note to clients, energy analyst John Gerdes of SunTrust Robinson Humphrey/The Gerdes Group said “gas market fundamentals are looking increasingly bleak over the next couple months as a confluence of events suggest the market will remain oversupplied in the near term. While not officially over, some forecasters are stating that the hurricane season is practically finished, leaving Gulf of Mexico producers unscathed. Mild weather continues to persist nationwide and is likely to result in further larger than average storage injections.”

Low spot market prices in the Rocky Mountains, said Gerdes, have led “some producers to publicly express consideration for shutting in production.” The Natural Gas Supply Association reported Thursday it does not expect any major shut-ins because of lower gas prices, but there may be some deferred production; on Wednesday, Chesapeake Energy Corp. announced it would shut-in 125-150 MMcf/d (gross), which is most of its remaining unhedged production (see related stories).

According to Gerdes, the Energy Information Administration storage capacity estimate of at least 3.6 Tcf could mean that “volumes approaching these levels are likely to encounter significant line pressure, which would restrict actual volumes in storage. With approximately seven more injections expected during the remainder of the cooling season, storage levels are likely to bump up against these constraints.”

If the price of gas remains low, development plans by U.S. oil and gas producers and liquefied natural gas (LNG) terminal operators could take a hit, a Standard & Poor’s (S&P) credit analyst said on Thursday.

S&P credit analyst Ben Tsocanos said producers are continuing to spend money on exploration and are still on the prowl for new reserves through acquisitions and mergers. North American drilling rig activity, he said, remains at “very high levels despite high service costs,” and producers also seem undeterred by related higher finding and development costs.

Winter weather, however, is the big swing factor, he said. If there is no strong winter heating demand, lower prices could put some producers at risk.

“Gas producers that have experienced all-in cost inflation to above $5.00/Mcf and are not meaningfully hedged could be pressured under this scenario,” said Tsocanos. “If prices continue to fall or remain low, they “could squeeze gas producers if the response time to cut back production is delayed. Two reasons for concern would be a reluctance to view the price drop as permanent, and a need to realize production at a certain price to make the agreed-upon economics fit the amount of leverage used.”

Lower gas prices also may increase the risk for LNG terminal development in the United States, Tsocanos noted.

“LNG’s potential impact on longer-term U.S. natural gas pricing wanes each time plans for a new terminal are mothballed, at a time when competition for LNG cargos is brisk throughout the world,” he said. “This may persuade producers that natural gas prices will remain above levels experienced in previous troughs, thus justifying high price multiples for proven reserves.”

Even though gas supplies heading into the winter season are strong, “an early cold snap in the Midwest or Northeast would rocket the spot price up to — and possibly above — the forward pricing strip,” said Tsocanos. “But warm weather could produce the opposite effect. Moreover, natural gas prices have retreated further than oil, as they have fallen by about two-thirds from 2005’s post-Hurricane Katrina high.”

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