Analysts Cut Price Projections as Storage Rises

In light of natural gas storage injections far outpacing last year's schedule, a sluggish economy and lost demand only trickling back to market, energy analysts from UBS Warburg, Salomon Smith Barney (SSB), Lehman Brothers and ABN-AMRO have taken another look at their respective companies' 2001 gas price forecasts.

SSB's Robert Morris said early last week that he was lowering the full-year 2001 composite spot gas price forecast to $4.65/MMBtu from $5.00/MMBtu, while keeping the 2002 forecast at $3.75/MMBtu (see NGI, June 11). He said the key to determining gas prices going forward depends on how quickly the "lost demand" returns to natural gas. Currently, Morris attributes 3.5 Bcf/d of the 5 Bcf/d of lost demand to fuel switching, when customers moved away from gas and used alternative fuels due to high composite gas prices. The remaining 1.5 Bcf/d of lost demand is attributed to reduced consumption related to economic factors.

"Even if natural gas prices returned to $3.50/MMBtu tomorrow, all of the lost demand may not immediately return to natural gas, given that part of it is related to overall economic factors," said Morris in a report released last Tuesday. "Also, industrial and utility users may want to be assured that natural gas prices won't escalate again in the summer before incurring the cost and effort to switch back to natural gas."

Last Monday, Morris said that prices were again weighed down by strong storage injection numbers --- 117 Bcf --- from the American Gas Association, although he noted prices "did firm a bit at week's end [June 8] with a revised outlook for warmer temperatures..." He said the pace of storage injections over last year had narrowed as expected for a second week, given that some fuel switching demand returned to gas after prices plunged to a 10-month low.

"However, we believe that the year-over-year storage surplus will continue to expand, while the increase in production this summer should essentially match the uptick in demand for power generation based on our economic assumptions," he said in his Exploration and Production Weekly report. "Thus, the key factor will be the return of the current 4.0-5.0 Bcf/d of lost demand."

The announcement last Wednesday of an injection of 105 Bcf for the week ended June 8 followed Morris' predictions almost to the letter, as the surplus continued to expand.

Thomas Driscoll took a slightly higher road, saying last week that Lehman Bros. was now forecasting an average (Henry Hub) gas price of $5.00/MMBtu for full year 2001, with a full year 2002 of $4.00/MMBtu (see NGI, June 11). He agreed that fuel switchers are key. "Gas prices may need to fall to allow increased consumption," Driscoll said. "At a price of roughly $3.75/MMBtu, we believe that gas would recapture 1.0-1.5 Bcf/d of demand from customers that are currently burning residual fuel oil, plus an additional 0.5-2.0 Bcf/d as a result of increased industrial demand and from decreased ethane rejection."

While remarking that storage injections on their present course could pile up a whopping 3,400-3,500 Bcf in the ground by the end of October, Driscoll believes that returning demand will not let that happen. Meanwhile, he estimated that last week's storage report would reveal an injection of about 100 Bcf (down 5 Bcf from his last estimate of 105 Bcf), compared to an injection of 78 Bcf a year ago. If only he had stayed with his first inclination.

Based on nationally mild weather, a "significant pullback in industrial demand," and a sagging economy, Ronald Barone of UBS Warburg also reported that his company is lowering its 2001 projection of the average gas spot price to $4.85/MMBtu from $5.75, while maintaining its 2002 forecast of $3.75/MMBtu. This compares to the current full-year 2001 Street consensus of $5.11/MMBtu.

Despite weak hydro power conditions and some fuel switching back to gas, due to low prices, Barone said he did not see many indications in the near term that demand would increase, sharply triggering prices. "The temperature outlook remains lackluster as does the overall strength of the U.S. economy," Barone said in his research note. "Moreover, the record injection pace has created a year-over-year storage surplus, which should provide enhanced system flexibility during potential heat waves or periods of hurricane supply disruptions over the balance of the refill season."

Barone pointed out that to reach the 2,800 Bcf comfort level by Nov. 1, storage would need to inject 65 Bcf a week, which is close to last years' average actual refill rate of 64 Bcf. He said he would "not rule out" an expansion of the surplus during the next several weeks. "Depending on Mother Nature, we cannot rule out supplies approaching capacity by Nov. 1."

James Whipkey, an analyst with ABN-AMRO, also reported a revision to his 2001 gas price forecast. Due to the above-average storage injections, Whipkey said in an update released last Monday that the company was lowering its 2001 forecast from $5.50/Mcf to $4.80/Mcf, while maintaining its full-year 2002 outlook of $4.20/Mcf.

Due to its 2001 revised forecast, ABN-AMRO said it was reducing its 2001 earnings and cash flow estimates on its entire coverage universe of E&P companies. "We recommend a cautious but opportunistic approach to E&P investing over the next three months," Whipkey said. "Sentiment has turned decidedly negative toward the group over the past several weeks, and we expect some further deterioration in what is shaping up to be a volatile summer season."

The company's "Buy" rating on the E&P sector reflects ABN-AMRO's view that after the coming period of volatility, supply/demand fundamentals will "become much more visible and defendable."

"Perhaps most importantly, we see the stabilizing U.S. production scene as somewhat illusory," ABN-AMRO said. As drilling shifts back to more statistically 'normal' activity, we expect the production to surprise on the low side." Whipkey said he recommends investing in E&P companies with strong future production growth rates and superior prospect lists, such as Apache Corp., Forest Oil Corp. and Spinnaker Exploration Co.

Morris' latest industry update agreed that E&P shares, on average, faltered a bit. "Overall, we remain somewhat cautious on the E&P sector at this juncture, given our view that there may be further downside near term for both crude oil and natural gas prices," Morris said. "However, valuations continue to reflect no more than $20.00/bbl WTI spot crude oil and $3.50/MMBtu composite spot natural gas prices, respectively, while we believe the longer-term fundamentals for natural gas prices remain solid."

Morris said he would still look to weakness in the group as the best opportunity to initiate or increase exposure. He highlighted Anadarko Petroleum, Apache Corp., Devon Energy and EOG Resources at the top of his list among the larger companies, and XTO Energy (formerly Cross Timbers Oil), Chesapeake Energy, Stone Energy and Vintage Petroleum leading the smaller-to-mid-cap names. The SSB analyst said that E&P shares declined 2.2% on average two weeks ago.

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