Lehman Analyst Says $2-3 Gas Possible

With the record levels of rig activity finally realizing an increase in natural gas supply, it is possible if the trend continues to see "a prolonged period of 'weak' natural gas prices" in the $2-3 range, according to Thomas Driscoll of Lehman Brothers. Supply growth, the current natural gas storage overhang, and weak demand could also lead to "lackluster" exploration and production share-price performance, the analyst warned.

In Lehman's Oil & Gas: Exploration & Production Industry Update, the company said U.S. production in the second quarter at the wellhead for a group of 37 producers -- which account for 60% of U.S. production -- has risen by approximately 1.7% over the past six months, implying a 2001 exit rate of 3-4% above year ago levels. Lehman Bros. said it also expects the sharp rise in U.S. production volumes to continue into the first half of 2002.

"We estimate that marketed natural gas production i.e., before the reduction in volume resulting from the removal of natural gas liquid constituents) for a sample of 37 large producers -- rose 0.5% in Q2 vs. Q1," Driscoll said in the Industry Brief. "This strong increase follows an estimated 1.2% increase in Q1 volumes vs. Q4. We estimate that 'marketed' natural gas production for this group of 37 companies is now 1.7% above Q4 levels and about 1.7% above year-earlier levels."

Driscoll said he believes that weak "dry gas" (gas after the separation of natural gas liquids) production increases have "misled investors" into believing that wellhead (wet gas) production has increased more slowly than it has. The lower prices experienced during the second quarter caused the industry to increase natural gas liquids production.

Reported gas production for Lehman's sample of 37 companies increased by a meager 0.14% from the first quarter to the second quarter primarily because 73% of reported volumes were from companies that report dry gas volumes. Driscoll said that wellhead gas production -- including natural gas liquids -- rose much more quickly.

"Preliminary Department of Energy estimates imply that NGL production rose 12.1% from Q1 to Q2," Driscoll said. Of the 37 companies followed, the "11 that break out NGL production reported that natural gas liquids rose an estimated 20.6%. After accounting for the estimated impact on reported natural gas volumes of higher NGL production (using either the DOE data or the company data) we estimate that wellhead production (includes both dry gas and natural gas liquids) effectively increased by 0.5%."

Production in Canada is also on the rise. The brief showed production from the North Country increased approximately 8% in June compared to a year ago, due primarily to the Ladyfern discovery in northeast British Columbia. Driscoll said proof of Canada's increase is evident in its 1+ Bcf/d increase in Canadian storage injections this year, and through the increase in imports to the United States. Imports from Canada account for approximately 15% of U.S. gas supply, Driscoll said, and he expects most of the increase in Canadian production will be tapped for U.S. markets.

As for the storage situation in the United States, Driscoll said he expects the current storage overhang, when compared to year ago levels, to increase to 350-400 Bcf by the end of October, and possibly to more than 700 Bcf by the end of the year.

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