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FBR Sets 2009 Gas Prices at $5 on Oversupply Concerns

FBR Capital Markets analysts Friday cut a dollar off their 2009 natural gas price deck and said prices could fall to $5/Mcf from $6 because of the saturated gas market.

New York Mercantile Exchange (Nymex) futures prices are currently implying an average 2010 price of $7/Mcf for natural gas and $60/bbl for crude oil, which is "materially higher than spot prices of $5.50/Mcf and $47/bbl," said FBR analysts Rehan Rashid and Michael Jones.

"We believe that the spot prices driven by continued demand headwinds and the threat of shale-driven supply growth will suffer downward pressure through 3Q2009," said the duo. "In fact, we are of the opinion that, if you see no capex [capital expenditure] cuts from 2008 levels, then 2009 would be oversupplied by 3 Bcf/d growing to 10 Bcf/d by 2011."

However, they said, "the reality is that capex cuts have begun, and our analysis suggests that the industry needs to reduce capital spending by $12.5 billion a year for the next three years to balance the 2011 market. We estimate that 2009 operating cash flows of the nearly 50 public E&P [exploration and production] companies we track (which account for roughly two-thirds of domestic spending) could alone drop by 35% ($25 billion) in 2009, from $71 billion to $46 billion."

Not only is the marketplace being saturated by prolific gas shale output, but "global demand slackness," could lead to more than 2 Bcf/d of supply increases in global liquefied natural gas (LNG) by 2Q2009, the FBR analysts said.

"In addition, we think that the start-up of meaningful shale gas infrastructure through mid 2009, fully connecting supply growth areas to demand centers, will be another bear market signal."

The FBR team has maintained 2010 and long-term gas price forecasts at $6/Mcf on the expectation that producers overall will reduce 2009 capex by 20% over 2008. For crude oil, the FBR price deck was reduced to $55/bbl from $70, with a long-term forecast of $80/bbl.

"The summer of 2009 will likely be challenging as shale supply and LNG enter the market, but the clear bifurcation of low-cost assets with growth potential versus marginal production will provide meaningful trading opportunities in the space," Rashid and Jones said. "We would note, though, that sustained material outperformance will be difficult until we get past the 2Q2009-3Q2009 bottom in natural gas prices."

However, share prices for E&Ps may have bottomed out, said the analysts. They noted that the independent E&Ps underperformed the commodity-weighted benchmark (70% natural gas/30% crude) by 7% from July 1, to Oct. 17, but since then, they have outperformed that index by 24% and outperformed the S&P 500 by 9%.

"We believe that E&P equities, taking a cue from the rapidly evolving contango in the Nymex futures market, bottomed in mid/late October, while spot commodity prices continue to search for a bottom, which in our opinion, should occur in the summer of 2009," said Rashid and Jones.

Now, "equities will try to look past 2009 and take cues from the magnitude of capex cuts and decline curves despite near-term spot prices...In the near term, commodity sentiment could benefit from pending winter weather and a natural-gas-friendly administration, and we believe any validation of the current contango should provide catalysts for a sector rally."

The Energy Information Administration last week said the worldwide economic slowdown continues to reduce global energy demand, leading to additional declines in energy prices -- including a projected drop in the Henry Hub spot price to $6.25/Mcf in 2009 (see related story).

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