While few gas market observers would disagree that the recent gas price spikes have been significantly overdone, this does not rule out the possibility that there has been a legitimate tightening in the market, according to energy consultant Stephen Smith of Natchez, MS-based Stephen Smith Energy Associates.

Smith believes that lower gas imports and higher than expected commercial and residential demand may be at least partly responsible for a rapid decline in the gas storage surplus over the last several weeks.

Smith calculates the storage surplus based on a comparison of current working gas levels and weekly storage changes with average levels over a period in the mid-1990s rather than a simple five-year average. He believes the five years from 1994 through 1998 best represent “normal” storage activity.

Storage injections this summer greatly outpaced the “normal” levels in the mid-1990s, but something significantly changed several weeks ago. After last week’s higher than expected 111 Bcf withdrawal in the Energy Information Administration’s storage report, Smith calculates the surplus (as of Dec. 12) stood at 218 Bcf. However the weekly storage change indicates that the previously built gains seen during the summer have switched to significant declines. The weekly excess has declined from about plus-15 Bcf/week seven weeks ago to a minus-17 Bcf/week last week.

“The sharp multi-weeks decline in our measure [of the gas storage surplus] indicates that there is likely to be some fundamental basis for the upward price move,” Smith said in his weekly gas outlook.

However, he said very little of the storage surplus decline can be attributed to declining domestic gas production. Recent surveys show a 2-3% annual drop in production, said Smith. That is far less than the weather normalize increase seen recently in gas storage withdrawals. “This suggests that any ‘supply-based’ explanation would be most likely related to gas imports.”

Canadian imports easily could have fallen by 1-1.5 Bcf/d over the last two months based on the declines seen earlier this year, Smith said. He also speculated that increased LNG demand from Asia could have “bid away” some LNG shipments bound for U.S. markets. But those supply declines probably still would fall short of completely accounting for the large drop in the storage surplus.

“Could something have happened to suddenly stimulate gas demand over the last two months? Sometimes the simplest explanation is the best,” he said, noting that the largest swing away from the weekly storage surplus happened with the onset of cold weather. As much as a 7 Bcf/week increase in residential and commercial demand may have happened this year, Smith predicted.

While these factors may have contributed to a much tighter supply-demand scenario this winter, the market’s overreaction almost certainly will cut a large chunk of demand out of the market, he said.

“At $6+ levels, the gas price has massively over-reacted to these legitimate fundamental supply-demand changes. The ‘demand destruction’ shoe has yet to drop.

“With the assumption of $28 [crude oil prices] and normal weather for the next three months, we are projecting a target Henry Hub cash price range of $3.75-$4.75/MMBtu for mid-March prices,” a 25 cent increase from Smith’s last forecast, which accounts for the “sustainable components” in the recent gas market changes.

Smith is forecasting a 133 Bcf weekly storage withdrawal in this week’s EIA gas storage report. According to Smith’s calculations, a 133 Bcf withdrawal would be about 26 Bcf more than “normal” (the 1994-98 average). His storage forecasts over the last eight weeks have had an average error of 5.6 Bcf/week.

©Copyright 2003 Intelligence Press Inc. All rights reserved. The preceding news report may not be republished or redistributed, in whole or in part, in any form, without prior written consent of Intelligence Press, Inc.