Consultants at Friedman Billings Ramsey (FBR) have raised their natural gas price forecasts for 2003, 2004 and 2005 based on the conclusion that total natural gas supply will fall about 3.6 Bcf/d short of demand by 2005. FBR concludes that amount of demand will have to be priced out of the market, and the industrial sector will suffer the most.

The imbalance will be created mainly by declining North American wellhead deliverability and increasing demand mainly from power generators. The industrial sector will suffer under resulting higher gas prices, FBR said.

Natural gas production will continue to decline through 2005 by a cumulative 1.3 Bcf/d, according to the report. Imports from Canada also will fall by about 500 MMcf/d. Meanwhile, exports to Mexico are expected to increase to 1 Bcf/d. While LNG is expected to add 1 Bcf/d by 2005, the cumulative effect of all the changes is expected to result in a supply decline of 1.2 Bcf/d.

“We expect deterioration in deliverability to be driven by declining base Lower 48 natural gas production and lower imports from Canada with increasing exports to Mexico adding to supply tightness,” the consultants said. “However, based on our expectations of increasing LNG imports, continued ethane rejection and stabilization of domestic production beginning sometime in [the second half of 2004], deliverability declines should flatten in 2005.”

While supply struggles, changes in environmental restrictions and a greater dependence on gas-fired generation should push up demand for natural gas. FBR expects a 2.4 Bcf/d increase in demand from power generators under moderate economic growth conditions. New nitrogen oxide emissions standards will go into place next summer and expand in 2004, boosting demand for gas-fired generation, the report noted. Commercial and residential consumption also are expected to grow by 0.2 Bcf/d and 0.8 Bcf/d, respectively over the three-year period.

However, higher gas prices, averaging $4.40/Mcf this year, $4 in 2004 and $3.70 in 2005, will have a significant negative impact on industrial demand, the consultants said. FBR expects an incremental 2.8 Bcf/d loss in gas demand from industrial consumers.

The report predicts that four primary themes will emerge:

The bottom line for gas producers is positive, according to FBR consultants. They believe many producer stocks currently are undervalued. “The FBR E&P coverage universe is trading at a total enterprise value to 2003 revised cash flow ration of only 4.5 times, well below the historical fair value of 6.0 times,” they said. “In addition, our bullish three-year outlook for natural gas price provides a basis for multiple expansion, which will be driven by the sustainability of earnings, free cash flow and improved returns on capital employed.”

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