As natural gas production falls and prices remain high, U.S. chemical producers may be “crowded out” by price-insensitive customers that bid up the prices to a level that manufacturers cannot afford to pay, according to a comprehensive analysis unveiled Friday by two Lehman Brothers analysts.

Falling supply overall may lead to a drop of 4%- 4.5% in consumption this year, and prices are expected to remain around $5.25/MMBtu, according to analysts Thomas R. Driscoll and Sangita Jain. The 2003 price outlook is supported by a need to “aggressively” refill storage during the traditional injection season.

“We are concerned that constrained natural gas supply and high natural gas prices could lead to falling natural gas demand in the future,” said the analysts. They focused on the 34% of total U.S. demand that comes from the “other” industrial sector, as defined by the Energy Information Administration. Overall, fuel and feedstock consumption is about 20% of total U.S. gas consumption — is 10.5-11 Bcf/d, including natural gas liquids, according to the analysts.

Manufacturing gas demand excluding agriculture, mining and construction covers about 89% of total “other” industrial demand. “For 2003, we estimate that the industrial manufacturing sector will consume roughly 18.6 Bcf/d (or 89%) of the total 20.8 Bcf/d of EIA’s estimate of ‘other’ industrial demand,” they said. Meanwhile, the chemicals industry, “by far the largest consumer within the manufacturing sector,” accounts for about half (48% in 1998) of the total natural gas and NGLs consumed by the manufacturing energy sector.

Historically, the United States has been the leading global chemical supplier, with exports approaching 13-15% and net exports at 5-7% of U.S. chemicals production. However, up to now, gas has been “abundantly” available to chemical manufacturers at a “favorable price and a favorable oil/gas price ratio, allowing them to maintain a competitive edge in world markets.”

However, the analysts noted that as supply has fallen and prices have increased, it is “more difficult for natural gas-based chemical plants in the United States to compete against manufacturers in Western Europe and Asia.”

According to the analysis, gas demand increased by 2% in 2002 “despite a 5.4% drop in new supply (production plus net imports) due to a net contribution of 1.6 Bcf/d into storage compared to a net injection of 2.8 Bcf/d in 2001 — a swing of 4.4 Bcf/d.” They believe this was a “one-time phenomenon, and we believe that demand is set to fall by 4% to 4.5% in 2003.

The Lehman analysts estimate production will fall 1%-3% a year over the “next several years,” supplemented in the United States by rising imports of liquefied natural gas…”however, increased imports are unlikely to be sufficient to allow overall demand to grow.” They said that the “key determinant of future U.S. natural gas prices will be the price that customers (especially energy-intensive gas users such as petrochemical, fertilizer, metals, paper, paperboard and power producers) can bear, rather than the price that producers need to earn a return.”

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