The near-term risk of more natural gas price erosion led analysts at ABN-AMRO and Lehman Brothers to downgrade their 2002 forecasts for several U.S. exploration and production company stocks this week. ABN-AMRO lowered its view of 2002 natural gas prices to $3.75/Mcf from $4.20/Mcf, but noted the new level “still represents a lofty and highly profitable commodity price for E&P companies.”

Meanwhile, Lehman Bros. lowered its 2002 and 2003 forecasts to $3/MMBtu, versus its previous forecast of $4/MMBtu in 2002 and $3.50/MMBtu in 2003. It also lowered its 2001 forecast for the rest of the year to $3/MMBtu, down from $4.10-$4.15/MMBtu.

In their E&P “Flashnote” this week, ABN-AMRO analysts James Whipkey and David Tameron said that the decreased estimate reflected the “reality that current storage levels are 150 Bcf above those of last year,” along with “looming sequential earnings declines, near-term risk of further natural gas price erosion and resulting multiple compression.” Fellow ABN-AMRO analyst Eugene L. Nowak also lowered the forecast for several of the oil-heavy majors in the coming year because of lower natural gas prices.

Whipkey’s and Tameron’s forecasts mirror those of other analysts of late, who noted that the sluggish demand for natural gas is making for a cloudy summer ahead. They revised their second-quarter figures in mid-June, forecasting a natural gas price of $4.25/Mcf. “While we are not yet retreating from our third-quarter forecast of $4/Mcf, we are going into the quarter significantly below that level of $3.25/Mcf, driven largely by the risk that storage may approach capacity by the end of the third quarter.” The latest 2002 First Call consensus forecast is $4.10/Mcf.

Believing that natural gas is recapturing most of the demand it lost when fuel switching began in the first quarter of this year, the ABN-AMRO analysts still expect continued weakness in the price because of “general economic weakness and industry-specific shutdowns (i.e., fertilizer, aluminum, ammonia).”

However, a “bright spot” was found in their analysis of U.S. production, which they believe is not growing as much as the consensus forecast. “We expect data available in late July will indicate 2.0-2.5% annual production growth trend, driven largely by rate acceleration drilling. These low-risk infill programs are designed to extract known reserves more quickly in a high commodity price environment, at the expense of longer reserve lives and flatter decline rates.”

Although production volumes from the low-risk infill programs will artificially inflate the perceived growth rate in second quarter 2001 numbers, ABN-AMRO found that the “illusion will be exposed when third quarter production figures are tabulated. At that time, we expect that a sub-2% U.S. production growth future gains credence, possibly fueling a share price rally as the traditional heating season approaches.”

Although downbeat about current natural gas prices, ABN-AMRO analysts remain “solidly optimistic” about the E&P group values. “We remain convinced that long-term natural gas prices will remain above $3.50/Mcf for a variety of reasons,” including:

Earnings in 2002 for ABN-AMRO’s universe of 13 E&P companies will “come in 27% below the 2001 numbers, and 2002 cash flow should be 15% below 2001. Year-over-year quarterly comparisons are also going the wrong way — while second quarter 2001 was nearly double second quarter 2000, we will start to see negative comparisons in the third quarter 2001 relative to third quarter 2000.”

ABN-AMRO oil major analyst Nowak’s “Flashnote” also lowered the forecast for the oil majors because of natural gas prices. In the near term, “we remain cautious on the major oil group, but continue to advise a market weighting longer term.” Long term, he recommended a “buy” rating for Chevron, Kerr-McGee and USX-Marathon, and an “add” rating for Texaco, Unocal and Exxon Mobil.

Nowak said earnings forecasts in 2002 for the majors would be “generally well above consensus” because of “good U.S. refining and marketing performance, and some — but not major — improvement in chemicals.”

Analysts Whipkey and Tameron reduced the investment ratings from “buy” to add” for several E&P independents, including Newfield Exploration, Evergreen Resources and Ocean Energy. They also moved Nuevo Energy to “hold” from “add.”

In Lehman Bros.’ E&P update this week, analysts Thomas R. Driscoll and Philip R. Skonick noted that strong natural gas storage injection rates “tell us that the market is oversupplied and that gas prices may need to fall.” They said “if we continue to inject 4.2 Bcf/d more than the five-year average, we would reach a hypothetical 3,450 Bcf in storage at the beginning of November. This is about 450 Bcf greater than estimated target levels of about 3,000 Bcf.”

Lehman Bros. analysts also believe that the gas market has recaptured most of the fuel switchers, and said that they believe gas liquids production “has partially recovered.” However, they said they were “beginning to fear that the production response has been stronger than previously forecast,” and noted that both natural gas production volumes and imports were rising. “The recent high drilling activity levels appear to be generating a stronger than expected production response that will likely carry over to year-end and perhaps into next year,” further eroding prices, the Lehman Bros. analysts said.

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