With gas futures prices topping out at $7.70/MMBtu Thursday, it’s no secret that there is a natural gas supply problem in North America. Consultants at Energy and Environmental Analysis Inc. (EEA) say that problem will get even worse before it gets better, with Henry Hub gas prices averaging $7.50 all of next year and $8.50 in 2007. The current 2007 futures strip is about $1.00 less than that.

In its Monthly Gas Update on Thursday, EEA predicted that domestic gas production in the Lower 48 will grow by only about 1% per year on average over the next few years despite the recent sharp increases in gas-directed drilling.

Part of the problem is that a lot of the increased drilling has focused on nonconventional gas in which reserves per well are low and more wells are needed to develop a play and to reach a desired productive capacity level. There are some areas where productive capacity is growing much faster, noted EEA Director Kevin Petak, most notably in the Bossier trend and the Barnett Shale in the Carthage area of East Texas where multiple pipeline expansions have been announced recently. Other areas, such as the Rockies, also have seen productive capacity growth.

“But that productive capacity growth is only in a few areas, and in other areas on the flip side of the coin productive capacity is declining,” Petak said in an interview with NGI. “We have increased drilling activity, but a good bit of that activity is to offset declines elsewhere.”

EEA does see some productive capacity growth and expects prices to fall in September and October of this year when storage levels reach 3.3 Tcf and demand drops before the winter heating season kicks in. “There will be a temporary drop in the marketplace, but once you get into the winter, all bets are off,” said Petak.

Because of the continuing tightness in the marketplace, any sharp change in the weather will have a dramatic impact on gas prices, Petak predicted.

While domestic gas production is expected to grow 1% annually for the next several years, gas demand is expected to increase 2.2% this year and 2.6% next year before flattening out in 2007. Demand for power generation, in particular, is expected to soar 9.6% this year to 13.7 Bcf/d, 10.2% next year to 15.1 Bcf/d and another 5.3% in 2007 to 15.9 Bcf/d, EEA said.

“We’ve been bullish; This should come as no surprise,” said Petak. “The eye-popping number will come in 2007. The reasoning behind the 2007 number is that the supply-demand balance has not really loosened; in fact it has tightened even a little bit more. It will only loosen once the new LNG imports from new LNG import terminals start landing in the U.S.” Petak said EEA does not expect that to take place in a major way until 2008.

The other major factor affecting long-term domestic prices will be the cost of LNG, said Petak. There is a significant question about the cost of attracting LNG imports once the new terminals open. Worldwide gas prices are high, in fact higher than prices in the United States in many cases.

“Whenever I look out across the world and look at some of the futures markets in Europe and Asia, gas prices are also high in those markets,” Petak noted. “It’s a very interesting global energy environment right now. The supply-demand balance for a lot of different types of energy is fairly tight and it’s tight globally, not just in the U.S.

“Having said that, I have some concerns that the supplies of LNG imports that a lot of analysts expect to make their way to the U.S may not be firmed up for the U.S. and may make their way into other markets. The U.S. is not going to be able to attract LNG unless it is willing to bid that LNG away from other markets that may be willing to pay more for it. That is certainly a concern in the U.S. natural gas market right now.”

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