ESAI: Supply is Starting to Outpace Demand

Natural gas demand will rise with growth in electric generation, but gas supply appears to be growing at an even faster pace, according to Energy Security Analysis Inc.(ESAI). The firm said it now expects "continued downward pressure" on gas prices through 2002. It estimates that domestic production, Canadian imports and liquefied natural gas (LNG) will equal an increase in supply of 3.6% in 2001 and 4% in 2002.

In the company's June North American Natural Gas Stockwatch, ESAI said it believes that increased gas supply leaves a very real possibility that the response to the upstream sector of the gas industry may be overshooting demand given the current price levels. The report focused on an 18-month timeframe.

"When we did our analysis for this last report, we worked independently and said...they [supply and demand] certainly don't match up," said Mary Menino, manager of North American natural gas for ESAI. "It looks like supply is going to keep climbing and demand is responding to higher prices and turning down.

"In the electric power sector we still see increases in gas demand, but we see decreases in industrial [demand] as a result of price. The utility and residential/commercial sector is pretty much weather dependent," she added.

"We are forecasting that there will be some return to industrial demand over the next couple of years, but the net of it is [that] those increases in utilities and some return from industrial, with normal patterns affecting residential/commercial, will not lead to demand growth as rapid as projected supply growth," she said.

ESAI said part of the problem is that demand from industrial customers, which were faced with exorbitant gas prices, declined by 0.6 Bcf in 2000 when compared to 1999. Many industrial plants were forced to scale back or shut down when high prices hit because their business uses natural gas for energy-intensive processes such as chemicals, fertilizers, glass-making and metalwork. "The key issue for 2001 and 2002 is how much of this lost industrial gas demand will return if prices stay in the $4-5 range," the report stated. "We have estimated that industrial demand will revive about 0.3 Bcf in each 2001 and 2002.

Some top industry analysts agree that "lost demand" seems to be responsible for the recent strong natural gas storage injections. Robert Morris of Salomon Smith Barney and Thomas Driscoll with Lehman Brothers both believe that price levels hold the key for when lost demand will return, and how fast it will return (see related story this issue).

Due to its forecast that supply might well overshoot demand in 2002, ESAI expects to see the "classic free market's response to such a misalignment," prices will be forced down. The firm's price forecast reflects this position with average Henry Hub spot prices hovering around $4.00 for the remainder of the year. ESAI predicts it will average $4.60 in December, with a full year 2001 average of $5.00. For 2002, the firm predicts an average price of $4.50.

ESAI said the largest increase in production is in the Rocky Mountain region. Wyoming, Colorado, Utah and Montana combined to increase marketed gas production by 648 MMcf/d in 2000, which equals a 31% increase in Wyoming and a 21% increase in Montana compared with 1999 levels.

As the United States upped its gas production to cash in on 2000 prices, so to did Canada. Canadian exports to the United States increased by 6.3% during 2000 and are expected to increase again in 2001 but by a smaller percentage, Menino said. She pointed toward Sable Island and the Alliance Pipeline as the main reasons imports from Canada have increased.

Absent "meaningful long-range weather forecasts," ESAI expects a normal weather outlook going into winter 2001-2002, which means residential and commercial demand in 2001 will be lower than in 2000 with its cold early winter months. The firm points to the "state of the economy" as well as "conservation improvements" as two secondary indicators for commercial and residential demand.

As for LNG's contribution to natural gas supply over the next 18 months, Menino took a reserved approach. "We will see some increase, but not a lot in that timeframe," she said. "The new terminals...we are talking at least five years, if they get sighted. They are probably next to nuclear plants as the hardest thing to get sighted."

For more information on Energy Security Analysis Inc., or to inquire about the company's June North American Natural Gas Stockwatch, visit the company's web site at www.esai.com.

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