While many observers, including the Energy Information Administration (EIA), expect natural gas spot prices to continue a downward correction in the near term, consultants at Energy Security Analysis Inc. (ESAI) said they believe the production decline combined with above normal temperatures this summer in key demand regions could spell trouble in the form of a tight marketplace and higher gas prices.

Preliminary EIA data indicate that domestic dry gas production declined 5% in the first four months of the year compared to the same period in 2001. ESAI said in its North American Natural Gas Stockwatch that despite the rebound in drilling the downward production trend will continue through the summer and early fall months, setting the stage for a tight summer market.

“With the exception of the Pacific Northwest, most of the western half of the U.S., the Great Lakes region, and the Northeast are projected to have above normal temperatures in June and July,” said Mary Menino, senior analyst at ESAI. “These warmer-than-normal regions are also ones in which gas-fired power generation is especially important.”

In addition, the economy is rebounding leading to an increase in consumption from the industrial sector at the same time gas demand from generators is peaking.

“Taken together, expected increases in industrial and power generation gas consumption are expected to present a very challenging summer for the gas industry,” said Menino. She said ESAI is projecting Henry Hub spot prices to average $3.60 in the third quarter, up from about $3.10 currently. “We think prices have bottomed out at this point,” said Menino.

As demand threatens to surge this summer, domestic gas production will continue falling compared to last year, according to ESAI. Both ESAI and EIA project that gas production will fall by about 4% this year. While Canadian exports will offset some of this decline, ESAI believes U.S. production won’t rebound to levels seen last year until 2004.

Ron Denhardt, a gas consultant with DRI Wefa, said, however, the current storage situation shows a need for prices to continue falling. “At the current rate [of injections] storage probably would be around 3,300 Bcf at the end of October, which would be more than full. It’s not going to reach that so some kind of pricing correction is going to have to take place to make sure that’s not going to happen,” he said. “Weather adjusted storage injections are very high and that means the market some how has to loosen up. The economy is not recovering that fast, particularly in the gas-intensive industries and the power-intensive industries. Hydro generation is up so that’s offsetting any impact from an increase in electricity demand.

“We’re actually running an expected 4.7% decline in production this year but even when you do that you still fill storage up before the end of October. I think a lot depends on your assumptions about weather but I think there’s certainly room for prices to move down to $3 and possibly below that, particularly by September in October when storage gets full and the market has no where to put the gas.”

Lehman Brothers analyst Thomas Driscoll agreed with Denhardt’s assessment, saying that production actually appears to have flattened in the second quarter based on the estimates of 45 large producers (see related story). Driscoll said the industry needs to “recapture 2.6-3.2 Bcf/d of lost demand” to end the storage injection season on Oct. 30 at the traditional 3 Tcf level. Currently, the industry is on track to fill storage above full capacity at about 3.4-3.5 Tcf. “This will require a reduction in supply or an increase in natural gas demand,” he said. We believe that natural gas prices are likely to fall below $3 in order to recapture some of the demand that has been lost over the past several months.”

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