As long as high natural gas storage levels persist — now about 16% above historical levels — prices could drop to as low as $2.00-$2.25/MMBtu in the next few months, and as prices trend downward, weakness in the share prices of U.S. exploration and production (E&P) companies will persist, according to the latest oil and gas production research by Lehman Brothers analysts.

Working gas inventories now stand at 2,353 Bcf, about 379 Bcf higher than in 2001 and 395 Bcf higher than the five-year average, noted analysts Thomas R. Driscoll and Sangita Jain. Meanwhile, it remains unclear how much weakness in prices will be required to reach a balanced market, and “we believe that demand needs to rise by an average 2.5 Bcf/d over the remainder of the refill season to prevent storage from exceeding our estimated end-of-season storage level of 3,200 Bcf.”

Even the recent decline in gas prices so far has not resulted in any meaningful recovery in demand — but the next couple of weeks could tell the tale. “If natural gas consumers continue to remain on the sidelines, despite the recent weakening in prices, we may see some very low gas prices in the next few months. We would not be surprised to see natural gas trade in the low $2 range over the remainder of the injection season.”

Regardless of whether there is a higher demand, the analysts believe that prices “are probably still too high given the storage overhang and the lackluster demand for natural gas.” So, for the remainder of the injection season, prices will remain below those for residual fuel oil and, in fact, “any significant weakness in oil prices could lead to more weakness in gas prices.”

Driscoll and Jain also foresee flat second quarter production figures compared with the first quarter, and 5% below the results for the same period a year ago. Estimated Lower 48 production for all of 2002 now is expected to be 4.5-5.25% below 2001 levels. First quarter production had already dropped 3% sequentially and 4.8% year-over-year, they noted.

Large cap U.S.-based E&P stocks also have fallen about 11% in the past week, compared with a 6% drop in the S&P 500 over the same period. The reason: weak markets and changes in the Standard & Poor’s 500 Index. “Extremely weak U.S. equity markets and the removal of Royal Dutch from the S&P 500 all had an impact on energy stocks last week, as did falling natural gas prices. Unless we see a rebound in natural gas prices, we believe that E&P shares will weaken in the near term, and that investors should stay mostly on the sidelines.”

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