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Industrial Demand Growth, Crude Oil Link Support Gas Prices

A combination of underlying factors, some of them unexpected and not widely known, probably will lead to another record for average annual natural gas prices this year, speakers at GasMart in New Orleans said on Thursday. Some of the causes are clear, including lower production and record high crude oil prices, while others are not as clear, such as the weak dollar and rising industrial output despite high fuel costs.

"Price averages continue to go higher and although the forward curve is backwardated we have to anticipate that we are at a new level of higher gas prices. It appears that $2 gas prices probably will not return for many years to come," said Barry Goldblatt, managing director of derivative sales at Merrill Lynch Commodities.

John Scarlata, general manager of Gas Trading and Fuel Supply for New Jersey-based PSEG, who spoke on a different panel at GasMart on Thursday, said he believes the industry will never again see "gas prices that don't have a '5' in front of them."

The industry has entered a new era in terms of producing high prices at the same time as high storage levels, Goldblatt noted. It also is in a new situation regarding industrial demand, which apparently is not being reduced further as prices have remained high.

"Industrial production is at its highest level since 1997 with growth at about 17%," Goldblatt said. "There are a couple of factors there and one is the weak dollar is helping draw exports out of the U.S. It's affecting many of the major U.S. industrial and chemical manufacturers." The other factor is that industrials and manufacturers also are moving away from just-in-time inventories because low interest rates have lowered carrying costs. As a result, higher gas prices have not led to the expected temporary or permanent industrial demand destruction.

Phil Toews of Goldman Sachs pointed to the rise in oil prices and the closer link between oil and gas as the primary reason gas prices are so high and rising. He said there are a number of underlying factors pushing the oil market to record levels. There has been a steady rise in oil production costs, royalties overseas have been raised and other countries have increased other forms of taxes on oil production.

Several of the speakers said with the high correlation between gas prices and oil prices, natural gas still has room to rise. James Allison of ConocoPhillips said with a 6:1 ratio between crude oil and natural gas (based on Btu content), gas prices could rise to more than $8.

Goldman Sachs is predicting that gas prices will average $6.70 this year, which is up from its previous forecast for the year of $5.90 but still lower than current futures market averages. Toews predicted that aside from the factors already mentioned the drought in the Pacific Northwest could be among the significant events that keep gas prices up this year.

Toews also expressed some "disappointment" in LNG imports. He said $8 gas prices in Europe this winter attracted LNG shipments that could have helped pressure U.S. prices lower.

"We look at LNG as a solution to supply concerns, but so does the rest of the world," said Merrill Lynch's Goldblatt.

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