While market bears are currently in the driver’s seat and appear likely to push near-month futures prices down into the mid-$5s or possibly lower barring a sudden increase in hurricane activity, the bulls clearly have control of the out-months with the spread between October and January futures recently peaking at a whopping $4.70. Some analysts conclude that these spreads are a clear indication that lower prices won’t be around for long.

Despite the price discount due to the lack of a Gulf of Mexico-impacting hurricane, Raymond James analyst J. Marshall Adkins said the market has overreacted lower. “We continue to emphasize that the underlying fundamentals for natural gas also remain bullish, as we believe the market has overreacted to relatively large storage injections,” he said. “In a normalized weather scenario, we believe that the midpoint of U.S. natural gas will be linked to oil prices with roughly a 6:1 BTU parity price ratio. Assuming BTU parity of 6:1 and our 2006 oil forecast, fair value for gas in 2006 should be slightly above $10.00/Mcf.”

In the report, Adkins said his full-year 2006 crude oil price forecast is $67.56/bbl, up $1.50 from his previous estimate. His full-year 2007 forecast of $70 is $8 higher than his previous estimate. The analyst is expecting a full-year 2006 natural gas price of $7.54/MMBtu and a full-year 2007 price of $10/MMBtu.

Because of the current supply/demand balance and the warmer-than-normal weather last winter, Adkins said natural gas is trading well below the so called parity price ratio. “The exceptionally warm weather [last] winter has had a sluggish effect on natural gas demand, storage, and prices,” he said. “In fact, natural gas storage (currently at 2.9 Tcf) is approximately 11% higher [year-over-year]. However, on Aug. 10, the Energy Information Administration reported a 12 Bcf withdrawal from storage, which was the lowest July and August injection since 1999.”

He noted that longer-term, a return to normalized weather “should” drive U.S. natural gas prices back toward the 6:1 BTU parity price ratio. Looking at 2007, Adkins said assuming normal weather he expects a flat $10.00 price for each quarter during the year. “For 2007, our forecast for gas is 17% above consensus and 8% higher than the futures strip, reflecting our belief that a resurgence of price-sensitive gas demand (fuel switching/liquids stripping, etc.) and/or production shut-ins at current gas price levels should leave us with storage levels closer to 3.4 Tcf at the end of October versus the widespread investor forecast of 3.7 Tcf,” he said.

Virginia-based consulting firm Energy and Environmental Analysis Inc. (EEA) said it expects Henry Hub prices to end the year at an average of $6.90/MMBtu, or $1.90 lower than last year, but expects a “significant” increase in 2007 and 2008.

According to EEA, the reasons for the lower gas prices this year are clear. Current gas storage inventories remain at record levels, U.S. gas production is expected to return to what it was before Hurricanes Katrina and Rita before the end of the year and the hurricane outlook is “more normal.”

Going forward, the overall gas supply/demand balance “remains very tight. Assuming normal weather, natural gas prices should rise significantly over 2006 levels. We expect both 2007 and 2008 Henry Hub prices to average in excess of $8/MMBtu,” EEA said.

EEA said several factors will drive the higher prices in the next two years. Among them are storage levels, which are expected to return to historical averages. Assuming normal weather, heating season-ending storage levels for both 2007 and 2008 are projected to range between 1.3-1.2 Tcf, “or more than 400 Bcf below levels that occurred in March 2006,” EEA said.

High oil prices also will limit fuel switching, according to EEA. Residual oil is now trading at $8/MMBtu. “Natural gas prices must rise above that level before any significant switching from gas to oil begins.”

The power sector’s growth will drive prices up as well. With normal weather, average annual gas use in 2007 is expected to be at the 2006 level of 14.9 Bcf/d, said EEA. Power sector gas use in 2008 will be around 16.2 Bcf/d “as incremental growth in electricity sales is mostly met with additional gas-fired generation.”

EEA also expects to see “modest” increases in liquefied natural gas (LNG) supply, with imports at 2.1 Bcf/d in 2007 and 2.3 Bcf/d in 2008, versus 1.7 Bcf/d this year. “The 1.5 Bcf/d Cameron LNG import terminal in Louisiana begins operation in late 2008. The 1 Bcf/d Costa Azul terminal in Baja [California] Mexico is projected to begin operations in mid-2008.”

Finally, EEA is forecasting only modest growth in domestic gas production. “Driven by the increased level of drilling activity, U.S. natural gas production is expected to increase to 53.2 Bcf/d in 2007 and to 54.5 Bcf/d in 2008, versus a level of 51.6 Bcf/d in 2006. Over half of the 2007 increase is due to hurricane-related outages coming back on-line.”

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