The tightness of supply and demand has set the stage for “sustainable” $3.50-$4.00/Mcf natural gas prices throughout 2003, but a lack of economically drillable prospects may lead to more mergers as producers look for production and reserve growth, according to a 2003 oil and gas industry forecast.

Portfolio restructuring among integrated producers and larger E&Ps will likely increase “selective” property acquisitions,” said CreditSights analyst Brian M. Gibbons Jr. “A combination of low prospect inventory, rising costs and balance sheet constraints…has led to a consensus expectation for moderate North American E&P capital spending increases in 2003.”

Gibbons noted that the oil and gas sector saw its debt levels ratchet higher through most of last year, reaching 49%, compared with 41% levels in 2001. However, higher gas prices, combined with a dwindling inventory in North America, also have increased producers’ incentives to drill.

“The North American natural gas market has also tightened considerably in recent months as U.S. and Canadian inventories have fallen dramatically, moving from 10% over five-year average levels to even, as producers have slowed drilling programs resulting in supply declines,” said Gibbons. “We expect 2003 supplies to remain dangerously tight in the absence of increased spending and drilling. Demand will depend heavily on a rebounding industrial sector, which accounts for 40% of U.S. natural gas consumption and a return to normal weather.

The effect of looking for enhanced depth and increased returns will spill over into the oilfield service and equipment companies as well, which will benefit from the rebounding North American natural gas market and record level of international activity. “We believe the North American spending outlook may be better than current conservative expectations owing to steep decline curves and falling inventories on the supply front, and a return to normal weather and improved industrial usage on the demand side. ”

Also, “international spending should remain at or near record high levels given higher drillable prospects and enhanced economics (i.e., larger discoveries and lower costs). ” The downside for may be balance sheet constraints and return of capital parameters of the North American E&P’s, said analysts. A “recurring theme of consolidation” in the energy sector will likely lead to higher-than-expected spending this year, and the deepwater market has the potential to “perform well given its larger resource potential.”

Overall, however, Gibbons noted that 2003 is forecast to be a “market perform year” for the oil and gas equities and bonds, driven by mixed fundamentals. The market appears to be “neither overly optimistic nor pessimistic” about the year ahead.

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