With the absence of warm weather and a lack of strong industrial demand in the near term, Canadian gas prices could weaken even more in the coming months, according to an energy industry update by Friedman Billings Ramsey (FBR). And while the rig counts have recovered somewhat, natural gas deliverability “remains a long-term concern.”

In his natural gas outlook for Canada, FBR analyst Amir Arif said near-term gas futures have declined 16% in the past month, “as declining crude oil prices, mild weather and relatively high excess storage inventory have taken their toll.” Because of a lack of warm weather and no strong “visible” industrial demand growth in the near term, gas prices may weaken in the coming months. “The upside for commodity prices in the coming few months is limited, given the near-term supply/demand outlook,” Arif wrote.

Longer term, however, “we expect excess inventory levels to begin declining as warm weather eventually arrives, as industrial demand continues to pick up with an economic recovery, and as high decline rates continue to place pressure on overall production levels in the face of current rig counts.”

Rig activity in North America is still low, relative to historic levels, the analyst noted. The declining rig count in the past two weeks “demonstrates the nimbleness and nervousness of producers regarding the commitment of additional capital to exploration and development activities in the current pricing environment.” FBR estimated earlier this month that a long-term natural gas price requirement of #3.30/MMBtu would be needed to “encourage longer-term, sustainable growth in the sector.”

As noted by other analysts, Amir said it is “most likely” that there will be additional corporate declines in natural gas production for the second quarter, “which should once again stoke the fires of deliverability concerns.” With “every passing quarter,” he said, “the strength and certainty of the economic recovery should become more visible, adding to industrial demand.”

Overall, based on year-to-date stock performance, Canadian independent producers will outperform their U.S. counterparts this year, said Amir. “With almost half of the year over, we noticed that Canadian independents have returned 19.18% year to date, while their U.S. counterparts have only returned 5.66% year to date. Given the lower valuations for the Canadian companies and the greater production and reserve growth opportunities in Canada, we expect this outperformance to continue…Canadian oil and gas investments could outperform even further if the U.S. dollar continues to weaken.”

Of the companies FBR covers, “Canadian Natural remains one of our top picks to outperform on a relative return basis.” FBR noted that “with the quality of projects in inventory, its low cash-flow multiple, relative to the group, and its balanced commodity mix…we expect the stock to outperform most of its peers over the coming 12 months.” Talisman also remains another “solid long-term buy,” said FBR. Under FBR’s ratings and price targets, Canadian Natural is expected to have an annual return of 54%; Talisman, 18%; Bonavista Petroleum, 28%; and Ketch Energy, 24%.

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