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Analyst: Robust Production, Weak Economy to Soften Prices

Bearish indicators for oil prices and robust natural gas production inform a lower 2008-2010 gas price outlook held by Stephen Smith Energy Associates. For this year the group is forecasting a $9.30/MMBtu average Henry Hub price, down from a previous estimate of $9.47/MMBtu.

Further out, the outlook for 2009 is for a bidweek average price at Henry Hub of $8.05/MMBtu, down from $8.65/MMBtu, and for 2010 the firm projects $8.30/MMBtu, down from the $8.95/MMBtu previously estimated.

"For several months it has become increasingly clear that the U.S. gas market could become oversupplied in the second half of 2008, and this condition might extend through 2009 and possibly into 2010," Smith wrote in his Monthly Energy Outlook dated Sept. 30.

Smith said the decline in gas prices "has slowed over the last month" and gave credit to hurricane shut-ins that have had a larger impact than previously thought. "We estimate cumulative shut-ins of 215 Bcf by mid-October," he wrote. While the hurricane aftermath lends price support, storm-ravaged Wall Street and turbulent markets dampen the price forecast.

Further slippage in oil prices is expected by Smith due to economic woes and spare capacity among the Oil Producing and Exporting Countries (OPEC). He's pegging West Texas Intermediate at $95/bbl for 2009 and plotting gas prices accordingly.

But perhaps more significant -- and more familiar to anyone in the gas patch -- is North America's shale miracle, which some believe could spawn liquefied natural gas (LNG) liquefaction facilities in the Gulf of Mexico.

"Total production has been ramping up sharply since early 2006, a period which includes the effect of some [hurricane] Rita/Katrina recovery in the early months, and the ramp-up of 1 Bcf/d from Independence Hub over the last few months of 2007," Smith wrote. "The main steady-state driver of production growth, however, is strong multi-year growth from the Barnett Shale and other important shale and unconventional resource plays.

"We now estimate 6% growth in U.S. gas production for 2008 as compared with 4.3% growth in 2007. The 2008 projection includes the effect of April-thru-early-June downtime at Independence Hub [see NGI, June 23] and an estimated 215 Bcf of actual and forecast lost production from the shut-ins related to hurricanes Gustav and Ike (beginning Aug. 28)."

Producers have begun to demur as evidenced by drilling cutbacks announced by shale star Chesapeake Energy Corp. (see NGI, Sept. 29). "While we may be the first [to cut back], we will certainly not be the last," Chesapeake CEO Aubrey McClendon told financial analysts recently. "In the business today, producers have made decisions based on $10-13/Mcf and they are running gas rigs. In the world we have seen in the last 60 days, we don't think there's enough cash flow there to support that kind of drilling activity."

And the slump could last a while. Restoration of supply-demand balance in the North American gas market is 12-18 months away, according to Smith. A hot summer and hurricane action next year could change that, but so, too, could a weaker global economy that softens global LNG demand and sends more cargoes to the United States, although Smith noted that LNG supply-demand is tight and likely to remain so.

On the demand side, softer oil prices have not dissuaded industrial end-users who can switch to gas from doing so. "With the enormous recent spread between gas and oil prices, it appears that the industrial sector is finding more ways to substitute gas for various oil products," Smith noted.

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