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Bearish Sentiment Persists -- but Case for Bulls?

The deteriorating U.S. economy and uncertainty of what lies ahead have prompted fears of a huge reduction in natural gas demand. However, energy analysts are making the case for both the bears and the bulls in 2009.

SunTrust Robinson Humphrey/the Gerdes Group (STRH) analysts think the collision of demand erosion with the rise in U.S. gas well productivity leads in only one direction: down. STRH on Wednesday cut its gas price forecast to $4.75/Mcf at the Henry Hub from $6. Analysts John Gerdes, Cameron Horwitz and Ryan Oatman noted that U.S. December/January industrial gas demand deteriorated by 2 Bcf/d year/year (y/y). They now expect 2009 industrial demand to fall almost 1 Bcf/d in 2009 versus 2008.

"On the supply side, recent production data suggests U.S. onshore well/rig productivity increased 25% in '08, above our previous expectation of 20%," the STRH team said. "With further deterioration in gas demand in late '08/early '09 and higher onshore supply exiting '08, it appears a sub-$5 gas price is necessary to lower the U.S. gas rig count and production sufficiently (800 gas rigs by this summer; 875 average '09 gas rig count)" to prevent gas in storage "from reaching its physical limitation" before next winter's heating season begins.

If demand continues to fall, there's more bearish news, said the STRH team. "Notably, we anticipate a further 30% onshore well productivity improvement in '09."

For Barclays Capital's trio of energy analysts -- James Crandell, Biliana Pehlivanova and Michael Zenker -- parts of the story have been untold.

"On the bearish side, the overall economy continues to weaken, and many expect industrial demand to follow suit," wrote the Barclays team. "Also while declining rig counts are a leading indicator that should ultimately arrest production growth, currently, U.S. supply is still growing. Indeed, weather-adjusted storage points clearly to a weak demand/growing supply conclusion."

However, the Barclays analysts said too many are forgetting about the impact of Old Man Winter.

"Cold weather has stoked heating demand and caused us to lower our end-of-March storage estimate," wrote Crandell and his team. "Also, rigs have been cut more quickly than we expected. We believe the current price direction, while fully accounting for bearish market news, has largely ignored bullish fundamental developments."

Last year "clearly was a remarkable year for supply growth, but a sufficient decline in the rig count could tip the U.S. into production decline by mid-year 2009," the Barclays team noted. "Weakness in industrial demand is inferred by the market and already priced into the forward curve, in our view. A rebound in economic activity at the end of 2009 could spur industrial consumption."

"Perceptions," said the Barclays analysts, have depressed prices, but "bullish fundamental developments have gone largely unnoticed."

According to Barclays, two "major bullish stories" remain untold.

"Weather has been extremely cold," the analysts noted. "Some will argue, rightly, that these cold temperatures illustrate that the weather-adjusted gas balance is much looser. That is, without cold weather, we would be awash in gas..." However, weather has turned bullish, and Barclays now estimates that by the end of winter, gas in storage will draw down to 1.6 Tcf versus a previous estimate of 1.8 Tcf.

In addition, rig counts are falling rapidly. If the gas-directed rig count falls below 1,100, "gas production will stop growing in the U.S." The rig count was only 85 away from that level for the week ending Jan. 30, Barclays noted.

"A handful of key uncertainties will affect the gas market's development in 2009," said the Barclays trio. "Producers' actions to trim the rig count will be balanced by their proven ability to squeeze more gas out of a single well. We expect production to tip to a monthly, sequential decline in 2009, and if demand recovers, the market to rebalance and cause prices to rebound in 2010."

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