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Analyst Sees Short-Term Improvement in Domestic Supply Picture

The gas market this year is shaping up to be a lot like the market last year and observers should expect a pretty big dip in prices this summer, according to Steve Thumb of consulting firm Energy Ventures Analysis Inc. (EVA) in Arlington, VA. Thumb said rising domestic supply will be the biggest difference in the market this year.

"It sure looks like supply is improving, so that has to be the biggest market change, even though it's modest," Thumb said in an interview with NGI. "There are four or five distinct areas where [domestic production is growing]. That is so much different than where we were in 2001, 2002 and 2003, when we declined 3.5 Bcf/d in U.S. production and 1.3 Bcf/d in Canadian imports.

"It's not increasing everywhere. It's not a 10 Bcf/d increase, but it is in an upward direction rather than a downward direction. Now we also have the production returning from infrastructure damaged by hurricane Ivan." Together they should result in a net production gain.

The modest increase in gas supply is expected to result from record gas-directed drilling, a significant increase in long-lived nonconventional production (shales, tight sands and coalbed methane), six major new deepwater discoveries (1.2 Bcf/d), a rebound in production from repairs after Hurricane Ivan and from a reduced dependency on the rapidly declining shelf production in the Gulf of Mexico, EVA said.

Production from the Shelf, or the shallow water in the Gulf of Mexico, has declined almost 50% since 1996 due to few reserves in new discoveries, high decline rates for existing production (up to 50% in the initial year for some wells) and drilling activity that is 35% below prior peak levels in 2000. The situation should result in continued declines in 2005 and 2006 in the region, according to EVA's Fuelcast Short-Term Overview.

In contrast, the industry has increased deep production (greater than 15,000 feet) from the shallow water areas by about 0.6 Bcf/d since 2000 and that growth is expected to continue over the next several years, EVA said. A key stimulus has been royalty relief from the Minerals Management Service.

However, while the track record for deepwater production has been superb over the last decade, it will be increasingly difficult to match it going forward, said EVA. A classic example of the production declines there is the Brutus field, which came online in 2001 at 110 MMcf/d and ended 2003 at 44 MMcf/d.

"With existing deepwater production at approximately 4 Bcf/d in 2002 and average decline rates at about 25% per year, production from new projects coming online must equal about 1 Bcf/d in order for deepwater production to just remain flat," EVA said. "While it appears that the industry will exceed this goal in 2004 and 2005...based upon announced drilling plans it appears that in 2006 there may be a slight decline in deepwater production."

In addition, LNG imports are expected to reach 2.3 Bcf/d this year and 3.2 Bcf/d next year from about 1.8 Bcf/d in 2004. "With respect to the intermediate-term outlook for LNG imports, at present there are six North American LNG projects under construction and another four could commence construction in the first half of 2005 (i.e., total capacity is 9.8 Bcf/d)."

Meanwhile, Canadian imports also are rising modestly. "You would think that would lead to improving fundamentals [and lower prices immediately], but the second thing is the enormous tension in the marketplace between the bulls, or the traders, and the buyers, or the fundamentalists," he said.

"It sure looks like -- independent of our forecast -- traders have jumped in with both feet [right now], particularly hedge funds, and are just pushing the thing right up in sympathy with oil."

The overall supply and demand balance also will remain relatively tight, Thumb said. EVA forecasts that gas demand will grow 3.6% this year from the suppressed demand levels in 2004, which had a mild summer. Nearly 60% of the projected demand growth will occur in the power generation sector.

"It looks like we will have a repeat of last year, where we will have very high prices until about June when it starts to decline." He noted that prices eventually fell below $4 last September before hurricane Ivan hit, but had been well above $7 in May.

Thumb expects the reality of high storage levels, rising production and increasing imports to hit the market by June. "Demand is higher this year, but it sure looks like there is more production and of course storage is so much higher than last year. At some point, maybe even mid-September or early October, [storage] is going to be full, they just plain won't need any injections, and at that point prices should [really fall hard]."

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