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Energy Analysts Expect Gas Storage to Be Low -- but How Low?

With the return to seasonal weather, one energy analyst is now estimating that natural gas storage levels will fall below 1,400 Bcf by the end of March. Another is predicting that gas storage will end the season at around 1,493 Bcf, which is 200 Bcf lower than he forecasted only three weeks ago.

Expectations for colder-than-normal temperatures over the next three weeks should take the year-on-year storage comparisons to a 300 Bcf deficit by the end of March, or below 1,400 Bcf of storage, Raymond James & Associates. Inc.'s J. Marshall Adkins wrote in "Stat of the Week." The normally bullish energy analyst said, "From here, further increases in natural gas prices should be more tied to increases in crude prices than further outperformance by natural gas. This is because natural gas has traded at roughly a 1:7 ratio with crude over the past decade."

When gas is "oversupplied," as Adkins said it was in 2006, the ratio to oil prices has risen as high as 1:10. When it is undersupplied, the ratio has fallen to as low as 1:4. Gas prices now are approaching a 1:7 ratio after averaging around 1:8.5 in the last year, Adkins noted.

"Many of the gas bears have pointed to increasing U.S. gas supplies and permanent destruction of industrial gas usage in the U.S. as reasons for a prolonged period of ongoing depressed gas prices," Adkins wrote. "We disagree with this view. We think that 2006 gas prices were depressed because of a gas storage 'overhang' that was created by 1) high prices at the end of 2005 that discouraged gas consumption and 2) extremely mild winter weather that destroyed substantial gas demand relative to normal weather."

The 12-month gas futures price strip is now around $8.25/Mcf, Adkins noted.

"If these higher U.S. natural gas prices hold, the stock market's anticipated meltdown in the U.S. drilling market may not be as severe as current gas-weighted stocks are discounting," Adkins wrote. "When the stock market psychology shifts toward a more bullish U.S. drilling activity outlook, we should see a renewed interest in the beaten-down North American natural gas levered stocks."

Energy consultant Stephen Smith was projecting three weeks ago there would be 1,715 Bcf in storage at the end of March. On Monday, he revised his forecast to a season-ending level of 1,493 Bcf.

"This sharp reduction is mainly due to the increased severity and duration of the current cold spell," Smith wrote. The weather pattern "changed abruptly" around Jan. 12.

"Six weeks ago the gas-to-resid spread averaged a negative $0.42/MMBtu -- last week's gas-to-resid spread averaged a positive $1.90/MMBtu," Smith wrote. "The current spread is more typical of early December -- a time when most of the winter lies ahead -- so the combination of both a long and cold winter cannot be ruled out. This will not be the situation on Feb. 23, a date for which we are projecting a 560 Bcf surplus."

Smith's "base-case" price outlook takes into account these factors: West Texas Intermediate crude will be priced between $50 and 60/bbl for several months; private weather service projections of heating degree days (HDD) through Feb. 23 will be higher; and there will be near-10-year norms for HDD thereafter.

"In this environment, because of our 607 Bcf projected storage surplus versus 10-year norms for March 30 (300-400 Bcf surplus effectively 'new norm' for the last several years), we estimate a March 30 gas-to-resid spread in the range of minus $0.50/MMBtu to plus $1.00/MMBtu." Smith estimated the "likely" April Henry Hub bidweek price will be $5.75-7.25/MMBtu.

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