Producers – and the lawyers, brokers and analysts they break bread with – last week received a second helping of what was for lunch eight months ago at Houston’s Petroleum Club: a bullish outlook for gas prices.

Nearly reprising the recipe for gas price strength served up by Coastal Corp. CEO David Arledge at the Texas Independent Producers and Royalty Owners (TIPRO) luncheon in February (see NGI Feb. 8), EOG Resources CEO Mark Papa ladled out more to make water the mouths of those with gas to sell. In a nutshell, production is lagging demand; winter is coming; and things are looking good for prices for a good while – but not so good, mind you, as to create a supply scare.

“In our opinion, we’re in the early stages of a multi-year supply constrained environment in North American natural gas,” Papa said last week. “This is not anything that just popped up in the last three or four months. This situation has been developing for at least the last two years, and it’s been masked, however, because of the extremely warm winters we’ve had the last two years.”

The ingredients of Papa’s bullish view are not a secret to the industry. He noted domestic gas production has been flat since 1994, even though most of that period saw significant gas drilling. Another item, year-to-date gas drilling is off 23% from a year ago. And decline rates are increasing in the United States and Canada to where both countries have aggregate reserve to production ratios of approximately nine years, Papa said.

“Now in 1999, there’s going to be a more severe decline in the deliverability of the U.S. It’s our estimate that between last Jan. 1 and this Jan. 1, we’re going to lose 2.2 Bcf/d of productivity in the U.S. just because we haven’t drilled enough wells. Now that is about 4% of the nation’s total deliverability. When you have a commodity, like natural gas, that has a very high price-demand elasticity [and] in one year you vacate 4% of that deliverability, you will see a price response, and that’s what we’ve seen today with gas prices.”

While Papa said he expects demand growth to average about 2% per year, the real gas price story is on the supply side. “If during the year 2000, we ran 600 rigs in the U.S., gas wells, year-round, it’s our estimate that all we would do is we would just offset the production declines that have occurred.”

In Texas, for example, gas production is off almost 6% for the first six months of this year compared to last. “Texas gas production is the lowest it’s ever been in the decade of the ’90s. So we’ve got some real issues here.”

In the Gulf of Mexico, new supply from deep waters is not offsetting declines on the Continental Shelf. And in Oklahoma, which produces 8% of the nation’s supply, production is down 6% during the first five months of this year compared to last year, Papa said. “So you’ve got a picture here where in the Lower 48 states, your breadbasket gas areas are having some trouble in terms of even keeping production flat, much less growing it to meet increasing demand.”

Papa said EOG expects an additional eight-tenths of a Bcf/d of gas coming to the U.S. from Canada this winter. The same is true for next winter, he said. But that only adds up to about 1.5 Bcf/d of additional gas for the winter of 2000-2001. “Just this year alone in the U.S., we’re losing 2.2 Bcf/d. So even with the increase in Canadian production taken a year out, you’re not going to offset the decline that we’re seeing in the U.S.”

Wrapping up his talk, Papa said the current “fallacy” in the gas market is that an industry hell-bent on drilling in 2000 will flood the market with gas during 2001. The EOG CEO is skeptical of that. Papa did stress that he and EOG are not projecting supply shortfalls that would keep the market from growing to 25 to 30 Tcf over the coming years.

NGSA Sees Adequate Supply this Winter

Speaking in Washington, D.C. last week, NGSA’s new president, Skip Horvath, insisted there will be no gas supply “shortfalls” this winter. As long as buyers are willing to pay the price, the gas will be there, he said.

“We see that word [shortfall] used commonly in our industry,” he said. “It is left over from our regulated days. Shortfalls, in economic terms, means that someone willing to pay for gas cannot get gas. We now have clearing mechanisms in place to ensure that shortfalls do not happen, such as capacity release, the secondary market, the grey market and merchant plants,” he told attendees of the Energy Information Administration’s Winter Fuels Conference.

Nevertheless, Horvath provided information confirming Papa’s conclusions about lower deliverability, but showing a less severe reduction. NGSA estimates show U.S. deliverability is down about 1.2 Bcf/d to 52.8 Bcf/d this year compared to 54 Bcf/d last year. Meanwhile, gas consumption is expected to average a whopping 81.9 Bcf/d compared to 73.8 Bcf/d in 1998.

Horvath said decline rates are growing 10%/year. The new wells being drilled have steeper and steeper fall-offs in production. Part of the reason is that technology is improving producers’ ability to find smaller fields and the older fields being tapped are more mature.

Currently, U.S. producers have to add 12.2 Bcf/d just to maintain flat production, compared to 11.3 Bcf/d in 1998 and 10.3 Bcf/d in 1997, said Horvath. With Papa, he noted that the number of rigs drilling for gas must continue to accelerate in order to meet demand over the next few years. But Horvath mentioned yet another bullish factor that has been talked about recently: labor shortages. Skilled rig operators are in short supply, he said.

Thomas A. Petrie, CEO of Petrie Parkman issued a similar warning last week at the 55th annual meeting of the Interstate Natural Gas Association of America in Aventura, FL.

Analysts See High Gas Prices Looming

If there were any market bears at the INGAA meeting, they were scared under the table by Curt Launer, vice president of the research department at Donaldson, Lufkin & Jenrette, and Petrie. Both speakers warned of tight supplies and higher gas prices. Petrie sees $30/bbl oil and $3/Mcf or higher natural gas in the near future.

“We’ve worked through a lot of low-hanging fruit in terms of supply that’s been developed in the last 10 years,” said Petrie. “There are marginal benefits to that and I think we’re coming up on a step function on the costs in the next round of supply. Somewhere soon I think we’ll hit a wall. There are things we can do to unlock the supply, but the maturity of the resource base at today’s level of economics is something that we have to think about.”

Launer concurred, though his bullish outlook was somewhat more reserved and based on different factors. “What we’re looking at is a very strong story for natural gas, and supply has not been keeping pace with demand growth. There have been a number of reasons for that.” One was the nuclear outages in the spring. Thirty-five percent of all nuclear plants were down this spring, the largest outage ever seen. That caused a shift to supplying electric generation from injecting gas into storage, which resulted in the large storage overhang compared to last year being reduced rapidly. That will have a lasting impact this winter and into next year, Launer predicted. Storage levels currently are 5% lower than they were last year, and if winter does decide to show up this year in contrast to last, there will be a significant price reaction.

However, at current prices the rig count already is growing rapidly and supply is recovering, he noted. “There are nearly 600 rigs drilling for gas right now. That is one of the self-correcting mechanisms in the industry. When the producers get more cash flow they immediately turn around and drill more wells.”

“The recent rig rate increases, while impressive, aren’t enough to correct the supply problem,” said Petrie, echoing Papa’s comments. Looking far ahead to the 30 Tcf market projected by 2010-15, Petrie said the industry will have to reach a new supply frontier in the coming years. He mentioned the Mackenzie Delta in the Northwest Territories, on which TransCanada PipeLines has its sights.

Joe Fisher, Houston; Rocco Canonica

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