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Lehman Analyst Sees Gas Prices Falling to Parity with Coal This Summer

The rumblings of a nasty gas market reversal can be heard loud and clear, said Lehman Brothers analyst Thomas Driscoll in a research note, predicting the current price collapse would continue into the summer.

With gas demand 10% below peak levels in 2000 to about 59 Bcf/d, gas supply on the rise and storage inventories much higher than average, the stage is set for prices to collapse to around parity with coal in the $5 area, Driscoll said Thursday. Meanwhile, near-month gas futures prices have plummeted from $8.192 on April 19 to $6.805 as of the close of trading Thursday.

"Prices rose sharply from the mid-$2 levels typical of the late 1990s as the market rationed increasingly scarce supply. We now think that supply is again on the rise and high price expectations appear to be discouraging increased use of gas," said Driscoll. "Summer prices are very vulnerable as weak demand combined with a huge storage overhang could force gas prices sharply lower."

Gas demand last winter was about 4 Bcf/d less than normal even after adjusting for warm weather, Driscoll said. Storage injections have been running 1-2 Bcf/d above historical norms, indicating that demand is still 1-2 Bcf/d weaker than normal or that supply has grown.

"We believe that we need to see summer demand improve dramatically to balance the market," he said.

Lehman Brothers estimated that industrial demand fell 5 Bcf/d from 2000 to 2005 as a result of declines in the chemical, paper, metals and petroleum sectors. Power generation growth offset about one-third of that decline.

"The 4% annual decline rate in industrial demand (still the biggest single sector at 35% of total gas consumed and one-third larger than power generation) is likely to continue if prices remain over $6-7/MMBtu."

Driscoll estimates that gas supply will increase 1-1.5% per year for the next several years as a result of hurricane recovery and increased LNG imports. U.S. gas production is expected to rise 0.7% in 2006 and 0.5% in 2007, following a 2.4% drop last year. "We expect U.S. production to resume a decline trend after 2007," he said. "However, if we adjust for the hurricane effects, we are estimating a 0.6% increase in U.S. production in 2006 based on [Lehman's] 1Q06 survey of the top 43 U.S. producers."

Lehman Brothers also expects Canadian imports to continue to rise. LNG imports are expected to double over the next three years, providing about 7% of total U.S. supply in 2009.

"We are forecasting a $1 drop in natural gas prices in '06 vs. '05 but the near-term downside is that natural gas prices will fall to parity with coal in the +/- $5 range," he said.

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