Several of the biggest domestic natural gas producers have drawn down on hefty reservoirs in the past two years, and at the same time, most of the increased drilling has been directed to regions with smaller first-year production totals. But even those trends may not ease the natural gas production decline going forward, according to the latest monthly report by Stephen Smith Energy Associates.

The Mississippi-based analysts noted that the basic conclusion remains that two years of drilling at $4-plus prices “could not reverse, on a sustained basis, a domestic production decline…The end result was that market balance was achieved by gas prices that were sufficiently high to destroy the most price-elastic demand.

With the decline in production continuing, analysts believe that next year and beyond, liquefied natural gas (LNG) imports will steadily rise. “The main reason is that Lower 48 and Canadian supplies yielded such a meager supply response to the recent price boom, and we don’t expect a much better response the next time markets turn tight. LNG imports are generally economic at $3.50-plus and may be a bit lower with advancing technology, and some sunk-cost receiving terminals.”

The drop in natural gas imports is in part because of a production decline in Canada’s once prolific Ladyfern field. But other problems also have caused the import decline, said analysts. “The gas price spike of winter 2000-2001 stimulated a visible increase in imports as the price -destruction of Canadian demand, and reduced liquids extraction, freed more gas for export. The subsequent easing of gas prices has also allowed buyers to draw on Canadian (and, in general, more distant gas sources) on more of a seasonal basis.”

Basically, said analysts, rising prices in 2000 led to rising imports. Lower prices, post-mid-2001, resulted in a steady decline in LNG import levels. Between December 2000-January 2001’s pricing peak, LNG imports actually declined about 0.2 Bcf/d, adding to the upward pricing pressure on gas markets. “We would attribute this to temporarily ‘running out’ of LNG supplies/tankers that had not been committed to contractual trade.”

Analysts also believe that natural gas prices will have to reach $4-plus for producers to take a risk on drilling their current prospects. They noted that the rig forecast has been increasing, while the actual rig count has been falling. “We attribute this effect mainly to a lack of good gas prospects for the industry as a whole. Drilling costs are currently low and gas prices will average $3.25 for the year, which is not bad.” This year, their model showed an average gas rig count of 693 rigs, while next year, the model indicates 772 rigs. “This projected 2003 level appears perhaps adequate to replace reserves, but not adequate to replace the production rate, since the reserves that are being found tend to have higher rate/production ratios.”

For natural-gas directed producers, gas fundamentals have been improving for the past nine months, said analysts, but exploration and production (E&P) stocks remain “stuck in a trading range.” However, “barring a freakishly mild winter,” they believe that a trading break-out will happen for E&P stocks in two-three months, driven by stronger gas prices. Assuming a $3.50/Mcf natural gas price in 2003, demand for gas next year will be about 2.5% higher, they noted. However, the same price assumption likely would result in gas production that falls about 2-3 Bcf/d short of meeting demand, suggesting that the “demand-destruction process” of 2001 could once again come into play, with prices moving above $3.50 to clear markets.

“For investors that can tolerate the nerve-wrenching volatility of the broader market for equities and the high risk of E&P investments, we would suggest a market-weighting or better,” said analysts. “The current market (mid-November) appears to be a good buying point for gas-oriented E&Ps.”

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