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Analysts Predict Storage Drawdown; '07 Price Forecast Cut

Now that much of the country has finally seen weather that can be called winter-like, Raymond James & Associates Inc. analysts are predicting that the current year-over-year gas storage surplus of 354 Bcf will be completely wiped out over the next three weeks and storage will stand at about 1,500 Bcf by winter's end. Further, they predicted that gas prices have seen their lows for the year.

However, analyst Ron Denhardt of Strategic Energy and Economic Research Inc. said with normal weather through March, storage would end the heating season at 1,746 Bcf, compared to 1,692 Bcf last year and a five-year average of 1,256 Bcf. He said the drawdown would come from a need to cycle inventories.

"We believe it is likely that storage operators will require storage to be drawn well below our model projections to maintain the integrity of the storage fields," Denhardt wrote in a Monday note.

In another note, a UBS analyst cut his price forecast for 2007 gas to $7.10/MMBtu from $7.75/MMBtu and predicted that Nymex gas prices will remain below $7/MMBtu until the storage overhang is worked off.

"Although this level of gas in storage is still well above (about 300 Bcf) the 10-year average, it would roughly be 200 Bcf below last year and, more importantly, it would be 300 to 400 Bcf below the current market consensus," the Raymond James analysts wrote in a Monday note. "If we are right, this could significantly change the market's outlook for natural gas over the coming weeks."

This winter has been about 15% warmer than normal but recent weather and the 14-day forecasts have turned colder than normal. "Given that 60% of heating degree days occur in January and February and we now have enough visibility on the weather forecasts, we have a much clearer idea of where we will end winter storage," the analysts wrote.

The National Oceanic and Atmospheric Administration (NOAA) predicts that the week ending Jan. 18 this winter will have 206 heating degree days, still warmer than normal but 21% colder than last year, the analysts noted. Based on NOAA's eight-to-14-day outlook the analysts assume that Jan. 18-Feb. 1 will be 5% colder than normal. "Lastly, we are assuming that we will continue to average (a weather-normalized) 2.5 Bcf tighter this year over last year," they wrote.

The year-over-year storage deficit would arrive by early February, according to the Raymond James analysts. Given normal weather for the remainder of the winter, the year-over-year storage differential should decline by approximately 200 Bcf more to get to a total inventory of about 1,500 Bcf by winter's end, they said. That's still above the 10-year average but substantially below last year's 1,700 Bcf and the consensus expectation of 1,800 Bcf.

"We are not saying that this approaching winter weather is going to be the catalyst that sends gas prices soaring back to $10/Mcf next month, but what we are saying is that gas prices have likely seen their lows for the year."

The Raymond James analysts cautioned investors that they should expect oilfield services 2007 earnings estimates to come down 5-15%, and the downward earnings revisions could temper the effect on share prices of stronger commodity prices.

Looking ahead to summer, Denhardt wrote that he sees bullish signs.

"Current weather predictions are for a warmer than normal summer and a very active hurricane season, but long-term weather predictions are very unreliable," he wrote.

Denhardt also noted that Canadian drilling has dropped sharply and with growing demand for gas in the oilsands patch, exports to the U.S. could decline by 0.5- 1 Bcf/d below last year's levels by June.

"The bearish factors for the coming nonheating season are growing U.S. natural gas production, the expected high level of working gas storage at the end of March and slower economic growth," Denhardt wrote.

UBS Investment Research Monday lowered its 2007 Nymex gas price forecast to $7.10/MMBtu from $7.75/MMBtu, maintained its 2008 forecast at $8.25/MMBtu and initiated a 2009 estimate of $8.25/MMBtu. The firm said its 2007 estimate is 6% below consensus while the 2008 and 2009 estimates are 5% and 4% above consensus, respectively.

"With storage sitting at 2.96 Tcf as of Jan. 12, approximately 49% of the winter in terms of degree days remains," the UBS analyst said in his note. "Consequently, the weather will have a major bearing on withdrawal levels of storage inventories and 2007E natural gas prices."

Under the UBS base case, storage would exit winter at 1,700 Bcf. Under the bear case, with weather 10% warmer than normal for the remainder of the withdrawal season, storage would wind up at 2,000 Bcf. Under the bull case scenario, with weather 10% colder than normal for the remainder of the withdrawal season, storage would end winter at 1,400 Bcf.

"Of these three options, the first two require weaker-than-expected pricing relative to our prior forecasts," wrote UBS analyst Bill Featherston. "Nonetheless, we maintain that medium-to-longer-term fundamentals for natural gas pricing remain healthy and the primary issue driving near-term natural gas price weakness is excess storage created by unusual weather."

UBS said that unlike last year, drilling activity likely will be impacted by lower commodity prices. Last years producers were watching the contango futures curve more than low spot prices. With the current Nymex curve flattened from last year's steep contango, "we expect the signal of lower prices to flatten (at best) natural gas drilling activity under our base case scenario and possibly lead to a 10-20% reduction in the gas rig count under our bear case scenario

"Given that the industry is so focused on unconventional resources and the attendant high initial depletion rates (often 50-70% in year one) of these plays, we'd expect a flattening or reduction in activity to rapidly impact domestic deliverability."

The UBS report notes that the supply-demand balance tightens when Nymex prices fall below $7/MMBtu and said the firm expects Nymex to remain below $7/MMBtu until the storage overhang is eliminated.

At the end of the nonheating season, with normal weather storage should stand at 3,405 Bcf, 48 Bcf below last year's level, said Denhardt. "Thus, we expect prices to be higher this nonheating season than last year," he wrote. "Of course, everything depends on the weather."

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