Lehman Shaves Gas Price Forecast

Continuing weakness in the gas market due to a sharp drop in demand prompted Lehman Brothers to lower its gas price forecasts for the first quarter and for the years 2001 and 2002. However, it maintained its gas price forecast for 2003 and raised its crude oil price forecasts.

Analyst Tom Driscoll dropped his wellhead forecast for the first quarter to $5.75/MMBtu from a prior forecast of $6.25 and took 25 cents off his forecast for 2002, leaving it at $4.25. His 2001 annual wellhead forecast is $5.25-$5.30, and his forecast for 2003 is unchanged at $3.50.

"First quarter natural gas prices --- using bidweek prices as our basis --- were weaker than we had previously forecast," said Driscoll in a research note, adding that bidweek prices were more than $2/MMBtu less than expected. "Our estimate for the remaining nine months of the year is largely unchanged at $5.30/MMBtu. As a result our revised full year 2001 Henry Hub gas prices forecast is $5.75/MMBtu versus a prior forecast of $6.25. We are trimming '02 estimates from $4.50 to $4.25/MMBtu but maintaining our '03 estimate of $3.50/MMBtu."

"Natural gas demand has fallen more sharply than we expected as prices rose. High natural gas prices/limited supply/higher heating needs appear to have caused sharp reductions in non-heating demand," said Driscoll. "Natural gas demand losses - using Q4-99 as our base - rose from an estimated 2.4 Bcf/d in early Q4-'00 to 7.5 Bcf/d as gas prices approached $10 in late December and early January. Major contributors to the demand losses were switching to residual fuel oil, decreased natural gas plant liquids production, reduced fertilizer production and decreased industrial energy demand."

The storage situation, however, has improved significantly, and inventories are in "much better shape than we expected," said Driscoll, adding that he expects storage to end the heating season with 650-700 Bcf of working gas rather than prior forecasts of 200-400 Bcf. "The additional demand from storage operators this summer will be about 1.75 Bcf/d, rather than the more bullish 3-4 Bcf/d that we had earlier anticipated."

Driscoll said he also expects competitive fuel prices to keep a $5.00-5.50/MMBtu ceiling on gas prices this summer. "At this price, plant operators are likely to produce NGLs, and gas fuel users will again burn gas in preference to distillate over the long run. An oil price level of $20-$25/bbl would allow natural gas prices to trade in the $3.75-$4.75 per MMBtu range before becoming non-competitive with distillate/NGL markets."

Another factor that could have a dampening affect on gas demand this summer is the slowing growth of the economy. The Department of Energy estimates that a 1% change in GDP translates into a 1.1% change in natural gas consumption. Lehman believes the relationship is even tighter with gas being the primary fuel for power generation. "We believe GDP [Gross Domestic Product] growth of 0-4% in 2001 would translate into electric power growth of -1% to +3% and natural gas demand growth for power generation (including IPPs) of between a decline of 250 MMcf/d and an increase of 1.5-2.0 Bcf/d."

Regarding supply, Lehman forecasts a modest recovery this year with production growth of about 2%.

Rocco Canonica

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