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Three's No Charm: Raymond James Cuts U.S. Rig Forecast Again

Raymond James & Associates Inc. last week once again cut its projected U.S. rig count, predicting a reduction of 41%, or 850, for 2009. However, even if 800 rigs are laid down, gas production shut-ins are likely next summer, analysts said.

"Although some components of our longer-term bullish outlook on gas remain in place, such as a steepening overall decline rate and lower Canadian imports, an extension of the surge in U.S. production from shale plays should dominate market forces for the foreseeable future," Raymond James analysts wrote.

Further, producers are making only marginal returns on some activity given Raymond James' price outlook. Look for "curtailment of at least the most marginal projects," they wrote.

Raymond James analysts reiterated their $6.75/Mcf price forecast for 2009. "Even after 300 Bcf of hurricane shut-ins, soaring domestic production has left the market within a stone's throw of last year's record-setting storage level," they wrote. "Industrial demand looks to have rolled over, and crude's continued fall now leaves residual fuel oil at more attractive prices than natural gas in the Northeast, which may cause switching back to oil."

In the longer term, declining industry activity and increasing decline rates should yield a long-term gas price that reflects current cost structures in the industry, the analysts said. "We believe this equates to a long-term average in excess of $8/Mcf."

For producers that can weather the storm, there is reason to be optimistic. The Raymond James analysts predict that as the benefits of domestic gas are recognized for their relative environmental friendliness and global gas markets develop, "eventual price parity with crude oil is likely."

In early October the energy analyst predicted that a gas floor of $7/Mcf "could easily be breached" if the rig count wasn't severely cut in 2009 (see NGI, Oct. 13). Two weeks later Raymond James energy analysts once again cut their rig forecast, predicting it would fall more than 10% year/year (y/y) in 2009 and drop off another 12.5% y/y in 2010 (see NGI, Oct. 27).

The rig forecast was substantiated by other analysts. Stephen Smith Energy Associates in late October predicted that the U.S. rig count would decline by 25-30% before a new supply/demand equilibrium was established (see NGI, Nov. 3). Barclays Capital in November also said the rig count would drop to 1,250-1,300 until at least the second half of 2009 (see NGI, Dec. 1).

Now Raymond James analysts think their first two forecasts were too low.

"Specifically, we now think there will be a 47% (or 750-rig) reduction in the natural gas rig count and a 23% (or 100-rig) reduction in oil-driven activity from peak levels," wrote Raymond James analysts J. Marshall Adkins and John Fitzgerald. "It should also be noted that we expect operators to significantly cut their activity in the coming weeks due to the holiday season and many of these rigs will not come back to work."

What's changed, said the duo, are the fundamentals, which "have deteriorated for both oil and natural gas prices due to the degradation of the global economy and the credit markets." Earlier this month Raymond James cut its 2009 oil forecast to $60/bbl from $90/bbl, and if prices remain low, analysts said the U.S. oil rig count, which had been growing in the Permian and Bakken areas, could see 100 rigs laid down.

A drop in natural gas drilling already has begun, the Raymond James analysts noted, pointing to the string of announcements to cut spending by exploration and production companies in recent days.

"With the rig count up y/y (through November), gas production gains versus last year should continue to grow through 1Q2009," wrote Adkins and Fitzgerald. "Even if we plug in our ultra bearish activity assumptions, U.S. gas production should continue to post y/y growth until the summer of 2009. For this reason it is already too late to correct the gas oversupply situation in 2009 without gas well shut-ins next year."

However, Raymond James' 2010 outlook has modestly improved. The gas supply response from a lower rig count in 2009 should result in a slightly undersupplied market in 2010 -- assuming the U.S. economy is rebounding by then.

"As we enter withdrawal season late next year, the gas production response should turn bullish for natural gas prices," the Raymond James analysts said.

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