Consultants at Energy and Environmental Analysis Inc. (EEA) are predicting that given normal weather, natural gas storage levels will drop to near record lows at 600 Bcf by the end of the traditional withdrawal season because of an alarming decline in U.S. natural gas producing capacity. However, an oil and gas engineer with the Energy Information Administration said he isn’t buying any “sky is falling” scenarios. He said productive capacity is very near where it has been historically.

In its Monthly Gas Update, EEA said it expects productive capacity will decline by 2 Bcf/d, or 4%, by the end of the year compared to summer 2001. As a result, supply will remain tight and prices will remain high, reaching peaks “well over $5/MMBtu” at the Henry Hub this winter.

EEA’s predictions differ significantly from those made Monday in the Energy Information Administration’s (EIA) Short Term Energy Outlook. While EEA sees Henry Hub spot prices averaging about $5.50 in the first quarter, EIA predicts wellhead prices will average only $4.16 in the same period. EEA sees domestic gas production down by about 3% this year, but EIA predicts production will be down by only 1.7%.

EIA’s production statistics have lagged both the information coming from producer’s quarterly filings with the Securities and Exchange Commission and the predictions of many other analysts and some consultants. Analysts at Raymond James & Associates and Lehman Brothers, for example, expect domestic production to be down as much as 6% this year compared to last.

EIA engineer Gary Long, based in Dallas, said he doesn’t place much credence in reports from Wall Street analysts. “I wouldn’t put any weight at all into all that gloom-and-doom stuff. It’s usually just bad reporting, misrepresenting the facts, or whatever you want to call it. There are a lot of alarmists out there.” EEA usually gets it right, but they may be a little off the mark in this particular instance, he said.

EIA statistics show productive capacity isn’t down as much as EEA predicts, and in fact, the capacity surplus — the difference between capacity and production — is near historical averages. “We have maybe a 1 Bcf/d [of productive capacity] drop from December 2001 to December 2002,” said Long, referring to a report on the issue that EIA will release after Christmas. “But production is down too, so the amount of surplus capacity available is actually about the same as it has been, 4 Bcf/d.”

But Long acknowledged that any time capacity utilization rates reach near or above 90% of capacity, as they have recently, there is a potential for significant price spikes. “The general conclusion of the report is that we have sufficient capacity, but if there is some event to trigger a sharp demand increase or a production cut, there could be high prices,” he said. “If you go back and look at 1999 when we had the big drilling drop, well, we have more productive capacity now than we had then, but it’s down from the peak in 2001,” he said.

In addition, there are some unusually tight spots to monitor. The Gulf of Mexico, for example, is expected to reach 100% productive capacity utilization next year, he said. Louisiana will near 100% utilization in 2003. New Mexico will be near 95% utilization. However, the average for the entire country will be around 90% utilization, which is about what it has been on average for the last decade.

The tight spots in some regions obviously are related to the sharp drilling decline from last year and possibly from back in the spring of 1999. When the rig count falls, it takes an increase of twice that amount to restore productive capacity. Producers have been unwilling or unable recently to turn the rig count around.

EEA predicts the lethargic response from suppliers this winter and next year will lead to $6.50/MMBtu gas prices next winter under normal weather conditions. EEA expects Henry Hub prices to average $4.94 in 2003 and $5.10 in 2004.

“The tightness of supply and demand in the U.S. market is becoming apparent,” EEA said. “Heavy pulls can already be seen coming out of storage. November withdrawals averaged approximately 6.4 Bcf/d. Last November, there was a net injection of 2.8 Bcf/d, albeit November 2001 was warmer than this November. Fortunately, working gas inventories at the end of October were relatively high at more than 3.1 Tcf.”

If the winter turns out to be colder than normal, EEA warned that storage inventories “could reach critical levels and threaten system reliability.”

The reason producers haven’t responded to the higher prices is largely related to their financial situation, according to EEA. “Liquidity concerns and tight credit markets in the current business climate are hindering the supply response.”

Lehman Brothers analyst Thomas Driscoll also recently noted that partly because of a continuing concentration on mature producing fields, unit costs have risen more quickly than the ability of producers to pass those costs through to customers. Producers have been spending more money this year than last, but producing fewer results.

This year “could be a major turning point for oil and gas producers,” Driscoll said in an equity research note (see Daily GPI, Dec. 5). Production per share, which is a measure of value creation, “fell dramatically in 2002 (by 5.6%) despite the reinvestment of approximately 100% of cash flow in the business.”

Higher gas prices eventually will induce a solid producer response, but EEA doesn’t believe that will happen next year. “We predict productive capacity will bottom out early next year and slowly rebound. However, productive capacity will not rise back to 2001 levels until sometime in 2004.”

A weaker than expected economy and lower prices for competing fuels will play a role in reducing gas demand this winter and next year, but the substantial weakness in productive capacity will offset any demand decline and maintain the tight balance, EEA added.

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