When EOG CEO Mark Papa opens his mouth, the words “bullish on gas prices” usually are among the first to come out, but this year Papa’s backing up his words with actions. None of EOG’s North American natural gas production is hedged in 2004 and 2005. Papa said he expects gas prices to remain above $5/MMBtu (Henry Hub) for at least the next five years.

“We’ve always been bullish on the gas price, and we have hedged less gas than the average of our peer companies,” Papa said during a UBS Warburg web cast. “We are about 20% hedged at about a $5.14 Henry Hub price, versus an industry peer group average of about 40%, and noticeably as of October our hedged level drops down to about 12% and we’re totally unhedged in ’04 and ’05.” That shows EOG’s confidence in its price forecast.

Papa said high gas prices this year are “pretty well preordained.” By EOG’s calculations, U.S. gas production fell from an average of about 52 Bcf/d over the last eight years to about 48.5 Bcf/d today. “That has very significant implications, 3.5 Bcf/d lost from the system,” he said.

“If you look at U.S. production, by our numbers it fell 5.3% [last year], the biggest one-year fall in U.S. gas production in the last 16 years. Canadian production overall fell in ’02 versus ’01, and our data for the first four months of this year shows it again falling in ’03 versus ’02. What’s important about this in a historic context is that it’s the first time you have had year-over-year production declines in Canada in 19 years.”

The Energy Information Administration (EIA), the main government agency that collects U.S. production data, disagrees with that assessment, however. EIA says domestic dry gas production fell only 1.8% last year and will rise by 1.4% this year and next year. EIA also expects prices to fall next year to about $4.11 (average wellhead) from an estimated $4.79/MMBtu this year, according to its Short-Term Energy Outlook. Further out, EIA sees prices falling back to less than $3/MMBtu. Despite EIA’s optimistic view on gas supply and prices, however, DOE Secretary Spencer Abraham last week called for a special meeting of the oil and gas advisory division of the National Petroleum Council to look into the “looming challenges” on domestic gas supply (see Daily GPI, May 19).

Few doubt that LNG imports will play an increasing role in the domestic gas supply mix. Papa said LNG imports should be up about 0.4 Bcf/d this year, but they will still average only about 1.5% of total supply. Meanwhile, Mexico will be importing about 1 Bcf/d from the United States this year and 1.5 Bcf/d by 2006.

“The bottom line is we have a stressed situation, but that’s pretty apparent for the rest of this year,” said Papa. “My best guess is you’ll definitely get storage filled to about 2.8 Tcf, and so I’m not too concerned about that. The question is at what price, and my guess is it will be something north of $5, whether that’s $6, $7 or $5.25, I can’t really tell you. But the important thing is I don’t think you’ll get storage filled to more than 2.8 Tcf and that’s going to put you on the knife’s edge for this winter. Remember last winter we started at 3.2 Tcf and we came close to running out of gas. If we start with 0.4 Tcf less than that, we are going to have to pray for a hot winter.”

On the long-term outlook, Papa is — well you might have guessed it — extremely bullish. He see the “next big tranche of gas,” coming from greenfield LNG terminals, which won’t happen until about 2007, he said. The next big events will be the two pipelines from the great white north; the Mackenzie Delta pipeline, which could deliver 1.5 Bcf/d at the earliest in ’08; and then the “big kahuna,” the pipeline from Alaska.

“The most recent data we have on that is that it [Alaskan pipe] will likely be sized at 4 Bcf/d and will show up in about 2012 at the earliest,” Papa said. “Well, I just told you that we’ve eroded 3.5 Bcf/d from U.S. supply in the last 18 months. The bottom line is that it will be several years before we get any supply fix, and even then, it’s probably not going to be a magnificently large fix.”

For cynics who are betting that this year will be a repeat of 2001, when high gas prices collapsed to $1.80 in October, Papa said, not so fast. “All I can tell you is the supply fundamentals are radically different from just two years ago. Today we have about 3 Bcf/d less in the United States and we have about 0.5 Bcf/d less in Canada, so I don’t see a situation where we replicate 2001. And there are not likely many changes on the supply side in either 2004 or 2005. If you look at the Nymex strip, it’s currently about $5 and in my opinion that’s a reasonable representation of what we are going to see for the next five years.”

Papa also said average well costs this year are down about 5% from last year, and competition for onshore land acquisitions is down significantly. “Surprisingly, competition for the kind of stuff that we do, which is getting new acreage, is much lower than it was two years ago…I can tell you that in 2001 we might have had five companies competing with us for that incremental acreage block but today we have maybe one company competing. The majors are non-existent in competing for new acreage [as are] a lot of the big cap independents.” Papa, however, said the majors have been actively seeking farm-in arrangements with large cap independents, such as EOG, on legacy acreage positions.

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