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Analysts Assail Hyped Gas Market, See Prices Falling

High oil prices, political hype, lack of adequate market information on either the supply or demand side and "bullish" media influence are among the key factors that have been propping up the price of natural gas, which is headed for a sharp fall, according to a newly-issued report by two leading energy analysts.

The authors assume that oil prices are likely to decline. "We project that natural gas futures prices will moderate significantly in the coming six to twelve months," to a range of $3.15-$4.65/MMBtu if oil prices return to the $22-28/barrel range, the report by James R. Choukas-Bradley and Michael F. Donnelly states. If oil drops to the $24-32/bbl range, gas prices will go to $3.40-$5.30/MMBtu. This supposes a 7:1 or 6:1 ratio between oil and gas prices, representing "a lasting change in the historical price of natural gas," which had been following 9:1 to 8:1 ratios.

If the oil price drop occurs before May, "spot prices may range between $4.00-4.50 for much of the summer and beyond, and should not be subject to fundamental pressures to return to current price levels."

Choukas-Bradley is a Washington, DC-based principal with the firm of Miller, Balis & O'Neill, with 24 years experience in the natural gas industry. Donnelly is a the fuels practice leader with Global Energy Advisors, has a Ph.D. in geology and is based in Vancouver, WA. He has 35 years of experience in the natural gas, electricity, coal and oil industries. The two said the views represented in the paper, "A Report on Projected Natural Gas Prices and Dynamics of the Natural Gas Markets for 2005 and Beyond," are their own and not intended to represent those of their companies.

The war premium on oil, estimated at $10-15/bbl, has had an effect on gas as well, to the tune of $1.65-2.50/MMBtu, the report says.

But "what is propping up current prices is....current prices," the report states, explaining that the natural gas futures contract on Nymex "continues to be dominated by technical trading, with the result that in a period of stability in market fundamentals, the market will tend to see prices remain at high levels if they start at high levels, just as they would remain at moderate levels if they started at moderate levels."

The technical dominance occurs because producers are risk-takers and tend not to hedge, preferring to capture the upside. That leaves the futures market to speculative traders with an incentive to support price volatility and volume liquidity, and it means that when prices start to fall they will fall hard. These traders rely on a variety of statistical tools with support and resistance levels, which, when breached trigger purchases or sales of forward contracts, accentuating the market movement.

Another prop for high prices has been the media, with the trade press "dominated by the interests of producers, with a bias in favor of higher prices that can support development of incremental supply for growth in consumer demand," the authors claim. The mass media is only indicted for preferring bad news, such as gas shortages, that make sensational headlines.

The authors maintain that besides media bias, there has been an all-encompassing political bias in favor of high prices. Republican politicos push the shortage scenario in order to get an energy bill giving more access to public lands. Democrats and environmentalists of both parties see the opportunity for incentives and mandates for higher-cost renewables. "Therefore there is wide political satisfaction, though largely unstated and politically unspeakable, for continued high gas prices."

It's not actual costs that have pushed up the gas prices, the report maintains. Costs are way below current prices. For the most expensive domestic production, deep water Gulf of Mexico, the full-cycle replacement costs may be as high as $3.25-3.50/MMBtu, the report says. Imported LNG falls near that range also at $2.75-3.75. Other North American full-cycle production costs are: overall GOM $2.75-3.00/MMBtu; onshore Gulf Coast $2.50-2.75; Canadian $2.25-2.75; and Rockies $2.00-2.25.

Despite the fact that there is no consensus among industry experts that domestic supplies are dwindling, "conventional wisdom" is that the nation is running out of gas. Projections through 2020 call for domestic production to increase or decrease annually by up to 2% either way.

Meanwhile, "projections of increasing demand are overstated," with electricity generation being "the elephant in the room" that no one can measure. "Very few natural gas industry players, even those with the most urgent need to accurately project gas prices, can accurately identify the number of new megawatts of generating capacity that are dependent on natural gas, their operational location within the energy and gas delivery grids, and their competitive economic performance." This makes it difficult to accurately forecast the real potential power demand for gas.

What can be forecast is that at $6-7 prices the gas-fired units will only operate as peak-shaving rather than baseload as combined cycle facilities. These would require prices in the $3.60-4.25/MMBtu range for continued operation.

The report sees industrial demand remaining static or continuing to decline and residential and small commercial demand remaining price in-elastic. In short, once prices fall, there is no fundamental reason for them to increase again. Elastic demand, or industrials that can switch to oil, will do so as oil prices fall, bringing down gas prices as well, the report contends.

For the long-term, however, the authors are concerned over the behavior of the majors and large independents in investing some of their "windfall" profits from domestic production in overseas projects, "largely owned by foreign national oil companies that they believe offer better investment opportunities, perhaps with payout in two-three years." In contrast companies would see a lower, longer-term return from incremental domestic production.

This means "the American consuming public is financing international projects," and the lack of investment at home is driving up domestic prices. The report also notes the multinational companies have an interest in developing the LNG market for their foreign-produced gas.

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