The U.S. natural gas market shows signs of improving, but maybe not as fast as some would "expect, hope for or need," a Houston energy investment banker said last week.

G. Allen Brooks, the managing director of Parks Paton Hoepfl & Brown (PPHB), said his firm's "best guess" about the domestic gas industry is that "the economic recovery continues, but with fits and starts. We expect the winter will be slightly colder than normal. Natural gas production will start to slide, but the enthusiasm of gas shale producers will mitigate the decline."

Gas prices, meanwhile, are expected to remain "range-bound" at $5-6/Mcf through the middle of next year. "The upper end of the price range may rise to $7/Mcf, but since we only expect about 2% annual growth in the U.S. economy next year, natural gas producers will be caught in the worst of all worlds." The Energy Information Administration last week said it expects winter gas prices to hover around $5/Mcf (see related story).

Prices should be high enough to sustain onshore drilling but they will be lower than what producers need to be "truly profitable," said Brooks.

Exploration and production (E&P) companies could "remain mired in an era of substandard returns on capital" going into the new year. "The ultimate result may be that by the end of 2010 the E&P industry is in the midst of a major restructuring that will once again change the face of the industry," said Brooks.

When the rig count began to collapse in late 2008, there were expectations that gas output also would fall and slow the build-up of storage inventories. However, he said "what wasn't understood well in this downturn was the role the highly productive gas shale developments were having on the gas production picture."

If gas prices go no higher than $5-6, combined with a high number of uncompleted wells and a mild winter, the PPHB team said it could be the "kiss of death" for the E&P industry in the first half of 2010. "The current high level of fundraising by producers -- selling stock, selling bonds, increasing bank lines and selling assets -- suggests that the level of financial stress within the E&P sector is growing. It is also possible that auditors and reserve engineers could make tough calls on company financials and reserve valuations at year-end, adding to the stress."

Another worry,said Brooks, is that gas production continues to grow as drilling intensifies in the most productive gas shale basins and more uncompleted wells are connected.

"Since the newly drilled gas shale wells all seem to have even greater initial production rates than the earlier wells in the same basins, the phenomenon of fewer wells producing more gas remains a stark reality," he said. "Even with a colder-than-normal winter in the Northeast region of the country, spring will arrive with significant gas volumes still in storage, which will depress gas prices throughout the spring and summer injection season next year."

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