Supply-Demand Tightness Should Continue

Despite the record rig count, gas production isn't picking up speed the way many expected, according to Robert Morris of Salomon Smith Barney. Gas production decline rates are extremely high, and the United States will be lucky to see production growth of 3% this year, Morris said during a conference call Friday.

"Overall we expect that the supply and demand balance will remain tight throughout this year at least as tight as last year keeping natural gas prices on a relatively firm course and our forecast for the full year is $5/MMBtu," said Morris.

"The overall decline rate for production in the U.S. has continued to climb. In fact since the beginning of the 1990s it has more than doubled. What that means is that overall we have to run harder every year just to stay in place," said Morris. He said overall production decline rates per well are averaging about 27% today, according to data from Dwights.

And at this stage the level of drilling activity is starting to plateau off with the gas rig count in the U.S. having reached 900. Last week the U.S. gas rig count dropped to 885 from 905. Prior to last year the highest ever seen was 650.

But the 40 largest production companies, which account for two-thirds of domestic gas production, reported only a 1% increase in fourth quarter 2000 gas production from the third quarter. They predict 5% growth this year but Morris said he isn't buying it.

A new field-by-field study of natural gas production from the Gulf of Mexico by McLean, VA-based Beacon Energy shows a 10.2% decline over 18 months in 1999 and 2000. The Beacon Energy study looked at data collected by the federal Minerals Management Service.

Production from the federal waters of the Gulf declined to 12.7 Bcf/d from 14.1 Bcf/d between January 1999 and June 2000, the latest month for which reliable data were available. The Gulf of Mexico provides 20-24% of the natural gas consumed in the United States.

The decline "explains, in part, the run-up in gas prices during the last half of 2000," said Jeff Brown, vice president of Beacon Energy. "Combined with high gas-fired generation demand during the unseasonably warm summer weather in California and the heating demand in November and December 2000 throughout the country, the coldest two-month period in more than a century, one can see why we have experienced extremely high price levels in the gas market."

The big question, said Brown, is whether the increase in drilling will provide the supply needed to meet rapidly increasing gas demand.

"This summer we expect to see the highest gain in demand for natural gas to fuel power plants seen to date," he said. "The combination of 20 GW of capacity placed in service in 2000 and an additional 30 GW in 2001 could test natural gas production capacity." Brown said the new generation "could add 5-7% to natural gas demand if we have hot weather and those new units see extended run times."

Morris doesn't see much help coming from Canada. Imports are expected to remain relatively flat in 2001. "Any significant uptick [in imports] will occur in 2002. We don't expect any help from Canada in augmenting our supply in 2001."

Fuel switching has provided some relief, bringing supply and demand more in balance. Switching reached 8 Bcf/d in January, but it has dropped recently to around 3 Bcf/d, Morris said. Some ammonia production plants are still off line because of high gas prices, but with the recent drop in prices some also are starting to return, he added.

Meanwhile, gas storage levels probably will exit March at roughly 700-800 Bcf, compared with just over 1,000 Bcf last year at the end of the traditional withdrawal season.

"Nonetheless, under most scenarios, incorporating numerous other variables such as the pace of economic expansion, fuel switching and industrial plant closures, it appears that storage levels at the beginning of winter will be near or below last year's 2,800 Bcf level," Morris concluded. "Thus, it appears likely that the 'heat' will remain on natural gas prices throughout 2001.

Rocco Canonica

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