Domestic third-quarter natural gas production showed yet another sequential decline, and trends suggest gas prices may move up in 2003, energy analysts suggest. However, other analysts maintain a decline in gas prices is more likely because gas isn’t getting any support from higher oil prices, which may be more relevant.

Analysts Jason Gammel and Michael Mayer of Prudential Financial’s oil and gas division, noted that even though there is declining gas production and weather-related demand, “we remain concerned about weak industry demand and ample storage levels, and believe the support from high oil prices is the most critical pricing determinant.”

In the Prudential analysts’ view, “the high oil price environment (which in our opinion is almost fully due to Middle East tensions) has supported natural gas pricing levels that are actually causing industrial demand to deteriorate. It is our interpretation that the market appears to have reconciled current storage volumes and relatively high pricing levels with a belief that continued sequential production declines will lead to a supply-driven market. Thus, we do not see a major catalyst for a rapid decline in prices until the uncertainty of early winter weather is resolved or oil prices contract.”

In the near-term, they said that the exploration and production stocks they cover “are now discounting $3.05/Mcf natural gas and on average have 6% upside to our target prices, which are based on a normalized natural gas price of $3.25/Mcf. We believe that a decline in commodity prices from their current levels is more probable than a continuing rise.”

Other analysts believe the sequential drop in gas production quarter by quarter will not fail to bring gas prices up in the near term, and perhaps be sustainable in the long term. In preliminary surveys of producers reporting 3Q results, analyst Stephen Smith said the production trend downward “has been persistent.”

In Smith’s latest “Energy Market Update” on Friday, his survey found another quarter of sequential production decline, this time a sequential decline of 1.4%, or better than a 5% annualized rate,”

He added, “combined with an 88 Bcf cumulative storm impact thus far, and a three-four week slippage in much Gulf of Mexico completion and hook-up activity, the overall supply trends suggest that gas prices possibly well in excess of $3.50 will be required to ration gas demand in 2003.”

Thomas Driscoll, an analyst with Lehman Brothers, also found that U.S. production continues to fall. Also preliminary, 30 companies of Lehman’s 43 are reporting that overall, production fell “roughly 0.9%-1.1% sequentially and decreased 5.2%-5.4% over year-ago levels.” Driscoll said in the second quarter of ’02, production was down 0.2% from the first quarter, which suggests a 5%-6% decline in U.S. production in 2002.

Meanwhile, Canadian gas producers in 3Q02 decreased an estimated 2.2% sequentially, and decreased 2.5% over year-ago levels. Totaling both U.S. and Canadian figures, 3Q North American volumes are “likely to fall 1.2%-1.4% sequentially and 4.3%-4.4% over 3Q01 levels.”

In the “high-end case,” Driscoll estimates that the full 43-company survey will show a 0.9% decrease in reported gas volumes versus 2Q02 levels and a 5.2% decline versus 3Q01 levels. The high-end results assume that the remaining 13 companies will meet Lehman’s production estimates.

In the “low-end case,” if the remaining 13 companies miss the production target of Lehman’s by an average of 1%, “production results will show a 1.1% decrease sequentially and a 5.4% decline on a year-over-year basis.”

Also under pressure are U.S. oil and gas refining and marketing companies, “as crack spreads and the light/heavy differential have been narrow, and remained under pressure throughout the third quarter of 2002, according to a report published Friday by Standard & Poor’s Ratings Services (S&P).

“Poor margins brought on by high commodity prices and lagging wholesale margins, compounded by capital investments to comply with environmental regulations, continued to hammer the refining sector in 2002,” said S&P credit analyst Brian Janiak in the report, “Ratings Pressure Increases in U.S. Oil and Gas Refining and Marketing.”

He said that continued weak refining margins “or a prolonged delay in the expected recovery of refining margins to midcycle levels by spring 2003 would cause many companies to borrow further to meet their capital expenditure budgets,” resulting in “further significant pressure on many refining and marketing ratings, with the likelihood of downgrades and/or negative outlook revisions.”

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