The gas market showed last week it was fed up with low crude oilprices getting all the attention. In a market swing that wasnothing short of unbelievable, gas prices collapsed to nearhistoric lows for a week in December. Spot prices at the Henry Hubplummeted to $1.01/MMBtu on Friday and averaged $1.32 for the week,down 64 cents from the week prior. Spot prices at a number of otherlocations in Louisiana and Texas fell below $1 on Friday.

Most of the nation sweated through Christmas shopping trips lastweek as temperatures reached record highs in at least 30 majorcities. Meanwhile, gas suppliers struggled to find places to puttheir gas. Storage levels already are at record highs for this timeof year, according to the American Gas Association, and are 471 Bcfhigher than they were at the same time last year. AGA reported anet 8 Bcf injection last week for the week ending Nov. 27, andthere’s a strong likelihood it will report another injection thisweek.

With prices so low and storage so high, there was a strongincentive last week to “hide gas” by socking it away amidpipelines’ linepack. As a result, linepack reached critical levelsand at least six interstates were forced to issue operational floworders.

“Gas prices have plummeted, and there is no place to store gas,no place to arbitrage gas and as a consequence we have the end ofcivilization as we know it,” quipped John Olson an energy analystfor Sanders, Morris and Mundy. On a more serious note, Olson saidthis will be an “Armageddon quarter” for producers because of warmweather, overloaded storage, $11 crude prices and SEC mandates torevalue reserves, not to mention commercial bankers demanding morecollateral or asset sales. “This is bad news. This is alsoreflected in the fact that oil well drilling is down 47% this yearand gas well drilling is running 20% lower than last year becausenobody has any money,” said Olson. “Producers didn’t even replacetheir production last year. They’re not going to come close todoing it this year.

“The consequences are that we are going to bring on the recoverysooner rather than later. The faster we go down, the better offwe’ll look,” he said.

“But there are a lot of producers right now in intensive care. Alot of people are struggling. .I think we are in for a shake-out ofsome major dimension. The small undercapitalized producer is indeedat risk.”

Donato Eassey of Merrill Lynch said he would expect the marginalE&ampP players to “just implode and sell themselves to the highestbidder they can get.” He sees “potential bankruptcies and the wholebit in the January-February timeframe” if gas prices don’t improvesoon. “You’ve got to have weather show up or it’s going to be’Katie, bar the door.'”

While the pure E&ampP companies are getting hit hard, however,this could be a “home-run opportunity” for companies like NationalFuel Gas, Questar, Coastal and Columbia Gas, said Eassey. They areboth utilities and E&ampP players and generally have high creditratings so banks are “flocking to them like crazy,” he said.

The major winners will be the “energy conglomerates, which usedto be called the pipelines,” Olson agreed. “These people havetremendous surplus cash flow, good pipeline profitability throughthick and thin, high-quality earnings and a necessity to grow byacquisitions. They are in the driver’s seat [of the productioncycle] because they’re the people that have all the money that canbail out the producers on favorable terms. They can get a call ongas and control the flow of the supply, and that’s the name of thegame.” Both Olson and Eassey agreed the diversified energycompanies are likely to jump in soon and start buying upsignificant properties and smaller E&ampP companies.

If crude prices persist at subterranean levels and gas pricesdon’t recover in the next 30 days, Olson said, the “shake-out” willbegin to develop. “You will see mergers to enhance businessprofiles, like Seagull and Ocean Energy, or mergers of necessity ofsmaller guys or outright cash sales. I would have to say a[significant number of them].”

PaineWebber analyst Ron Barone noted that compounding theproblem this quarter is the comparison with the fourth quarter oflast year, which was colder than normal. But he’s optimisticweather will change soon, possibly as soon as this week, and gasprices will recover quickly.

“Personally I don’t think this is going to last very long fortwo reasons: first it is supposed to get colder next week accordingto the National Weather Service and the Weather Channel, stillabove normal, but much colder than now with daytime highs [in NewYork City] near 50 as opposed to the 70 degrees that it is now. Theother reason is if prices stay this low, producers are going tostart to shut in. If they get to $1.60, producers start to runtheir economics, and it’s well below $1.60 now. Some discretionaryproduction will be withheld from the market if prices stay this lowfor an extended period of time.” Barone predicted shut-ins willstart to occur if prices stay in the low $1s/MMBtu for two weeks,which he thinks is unlikely because of colder weather approaching.

However, several Louisiana producers confirmed last week theyalready started curtailing production.

Curt Launer of Donaldson Lufkin and Jenrette Securities seeslittle long-term impact from this gas price crash mainly becausefew companies sell short-term spot gas anymore. “A lot of companieshave hedged production,” he noted. “A lot of companies have soldout in the bidweek period for the month of December, same thing forJanuary. So lets not overreact to the weekend spot market, which isso far below the futures screen.

“You’re talking about the weekend market right now. Somebody isselling that gas just the same way that somebody paid $7,000 for amegawatt hour in June. That’s the equivalent volumes we’re talkingabout. It gets a tremendous amount of press and it really ishappening, I’m not denying it, but it’s not the kind of thing thatwill swing the annual average price or any particular company’srealized price by anything more than a loss in the rounding.”

Launer failed to note, however, the power price spike in June,significantly impacted the earnings of several companies, some ofwhich were forced to close down marketing operations and take hugelosses for the quarter.

A Coastal Corp. spokesman, however, supported Launer’s firstpoint, noting that the company already has hedged all of itsproduction for December and has no plans, and sees no reason, toconsider production curtailment.

Rocco Canonica

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