If you got a lump of coal in your stocking this Christmas,rejoice. It could be the only thing left to heat your home by theend of winter. There is a growing consensus among gas marketexperts that there will be a shortage by March if the weather staysnormal or colder than normal.

This surprisingly cold winter has reduced gas storage down torecord lows for this time of year, and given predictions for morecold weather the storage situation probably is going to get worsebefore it has a chance to get better. The winter so far has been21% colder than the 10-year average and 35% colder than last year,according to Salomon Smith Barney. And below-normal temperaturesshould linger at least through the end of the year, according tothe most recent short-term forecasts.

Gas storage, meanwhile, is only 64% full. Last week, theAmerican Gas Association reported that storage fell 158 Bcf duringthe week ending Dec. 15 to 2,113 Bcf. Working gas levels are 457Bcf below the five year average and 630 Bcf below levels at thesame time last year.

The market acknowledged the storage problem long ago butcontinues to produce new records nearly each week. Last week was noexception. Futures prices for January delivery are fast approaching$10/MMBtu and some observers believe much higher prices are yet tocome unless the weather turns suddenly warmer, a significant amountof demand is removed from the market or a large amount of newsupply kicks in.

“It is difficult to identify how the market is going to avoidrunning out of gas without much higher prices and/or involuntarycurtailments unless we have extremely warm weather,” said WEFAInc.’s Ron Denhardt last week. Analysts at Petrie Parkman &Co., Raymond James and Associates, UBS Warburg and Salomon SmithBarney echoed his comments.

All of the analysts agreed that an average pace for storagewithdrawals for the rest of the winter would put working gas levelsin the negative column, which might be impossible given thepressure requirements for withdrawing gas from storage fields.

“At the rate winter is setting in, by the middle of Februarywe’ll be where we usually are in April” in regard to natural gas instorage, said Thomas A. Petrie, chairman of Petrie Parkman &Co. in Denver. “By March 15 we will be in a very serious situation.We’ll be digging into pad gas, and who knows how far you can diginto that,” he said. If the industry is able to tap into thecushion gas at the bottom of the storage cavern, “you’re just goingto have to replace it. The shoulder months are going to beunrecognizable.”

Analysts at Raymond James and Associates predict an”unprecedented gas shortage in the second half of this winter” andan $8/Mcf spot price average during the first quarter at the HenryHub. They said storage levels “should fall well below anything wehave seen in recent history.” Given normal weather for the rest ofthe winter, storage levels would have to fall to a “completelyunfeasible” -280 Bcf of working gas by April 1. “Keep in mind thatwe have never really tested the gas storage system below +600 Bcf.This means gas prices must continue to rise sufficiently throughthe second half of the winter to discourage between 5 and 10 Bcf/dof demand in the final 90 days of winter. In other words, the U.S.will likely see some form of price driven rationing of natural gasin the second half of this winter.”

Raymond James’ projections of storage withdrawals aresubstantially higher than the five-year average. The firm predictsindustry will withdraw an average of 182 Bcf/week through the weekending March 9, but over that period during the past five winterswithdrawals have averaged only 120 Bcf/week. Even with 120Bcf/week, however, there still would be only 673 Bcf of working gasin storage on March 9.

Salomon Smith Barney analysts Robert Morris and Michael Schmidt— probably the most optimistic of the bunch — predicted workinggas levels would end the winter no higher than 600 Bcf. “We believethat total natural storage levels cannot be drawn down to below 500Bcf due to physical limitations, which, if the winter maintains itscurrent course, could result in physical shortages of natural gasnear the end of this season.”

Ronald J. Barone of UBS Warburg said working storage levelsprobably would fall to 517 Bcf by April 1. “However, givenunderlying demand creep, the chilly weather outlook (and the factthat three of the prior six years were very mild), we cannot ruleout an exhaustion of supplies by April 1.”

Demand Reductions Critical

Petrie, Denhardt and the analysts at Raymond James said it willbe critical for the gas industry to cast off some demand betweennow and March. The market already has started to allocate supplies,with industries such as methanol, ammonia and glass opting outbecause of high prices. Prices continue to post new records andappear likely to cross the $10 mark for the first time in historyrelatively soon.

“In order to end the heating season with 500 Bcf in storage itwill be necessary to have some combination of supply increase ordemand decrease that adds up to 6 Bcf/d,” said Denhardt. “We simplycannot determine how this will happen.”

Denhardt said even if a huge 4% increase in U.S. productionoccurs during the remainder of the heating season that still wouldaccount for only 2 Bcf/d and is very unlikely to occur anyway. “Ifyou assume you lose half of the fertilizer industry (0.8 Bcf/d) andsome other industrial gas consumption, you may get 1.2 Bcf/d. This[with the unlikely production increase] all adds up to 3.2 Bcf/d,far short of 6 Bcf/d” required, Denhardt added.

Fuel switching is expected to take at least 1.5 Bcf/d out of themarket potentially much more. “This adjustment over about 14 weekswould bring storage levels to a plus 27 Bcf.” However prices haveto go much higher to knock even more demand out of the market, hesaid. Denhardt sees the potential for 7.5 Bcf/d of demand to becut. However, there are a lot of “ifs” involved, he noted. Much ofit would come from switching to dirty burning fuels andenvironmental restrictions stand in the way.

“Thus there is the capability for the market to respond,” hesaid. “However, there has not been an adequate response to date.Again, the question is what price level will be necessary… Thenumbers tell us that prices of $9/MMBtu at Henry Hub appear to bemuch too low…,” he said. “In fact it is difficult to determinewhat price will be high enough to balance the market unless we haveextremely warm weather. Further, the problem is more severe thanprices. There is a serious question of the adequacy of supply atany price this winter.”

Denhardt predicts this week’s storage report will show anotherwhopper withdrawal of 180 Bcf for the week ending last Friday. Thatwould leave working gas levels, according to the American GasAssociation, at 1,933 Bcf, which would be 637 Bcf or 25% lower thanlast year and 131 Bcf or 6% below the lowest level in five years.”[W]e project that is not enough gas in storage to get through theheating season,” said Denhardt. “Others have come to the sameconclusion.”

For the long-term, Petrie predicts “it will be a two to fiveyear work-out, if you have good policy responses,” before there isan optimum supply-demand match.

One of the policy responses that will be critical, the veteranoil and gas analyst believes, is building the Alaska pipeline.”There’s a good chance it will be built with Bush as president.”Unless the policy responses are forthcoming, the nation faces “asupply-induced recession. We’ve been living off surplus for a longtime.” Petrie likened the current situation to 1970 “when we ranout of oil. It took us 10 years to work out of that one.”

Rocco Canonica

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