Natural gas prices have weakened in recent weeks, but they may weaken even more in the coming weeks because of two things: corrections to the “huge” inventory overhang and weakening oil prices, which will put pressure on gas prices in the short term, according to Lehman Brothers in its latest “Oil & Gas: Exploration & Production Update.”

Analysts Thomas R. Driscoll and Sangita Jain noted that their forecasts, which predict an average gas price of $3.05/MMBtu for 2002 and $3.50 in 2003, are in line with similar forecasts by the Energy Information Administration (EIA) when compared on a wellhead basis. In line with previous forecasts that gas prices would fall, the analysts believe that prices may remain “below the $3 mark as the market works toward reducing the huge inventory overhang,” and oil prices fall.

As a “rough” rule, Lehman’s analysts said they divide the West Texas Intermediate/crude price by 7.5 to derive the “cap” on natural gas prices “before it becomes economic to switch to residual fuel oil. For the longer term, however we continue to believe that gas price strength will return following mid-summer price weakness.”

This year, the analysts noted that EIA projects gas demand to increase about 1.8% overall following unexpectedly low gross domestic production growth assumptions. Natural gas demand growth, however, is forecast to grow to about 3.6% from 3.1% for 2003.

“We believe that EIA’s demand growth forecasts may prove too optimistic,” they said in their new report. “As gas prices have risen over the past few years, industrial demand for natural gas has suffered. We believe that the 1.9% annual growth that the industry experienced from 1986 until last year was the result of competitive natural gas prices — helped by modest increases in domestic production and a surge in Canadian exports. The industry’s difficulty in increasing supply in the future will likely restrict future demand growth.”

Regarding gas supply, the analysts believe that declining domestic production will be supplemented by increasing imports, including liquefied natural gas. EIA, which first predicted a 12.5% drop in imports and eased it to a 5.7% decrease, may be off, said Driscoll.

“While the change is in the right direction, we believe that imports will be greater than those currently forecast by EIA and believe that imports will likely approach 2001 levels.” Lehman analysts estimate that the 4.5-5.25% drop in domestic production and flat import growth will “imply a 4-5% drop in new supply.”

While EIA’s 2002 outlook for power demand essentially is flat at about a 0.3% gain, analysts estimate gas-fired power demand will grow 1.8% through 2003, “the result of an increase in generating efficiencies.” However, if economic growth exceeds EIA’s expectations, analysts expect to see a “stronger increase in gas demand from economically sensitive consumers, putting upward pressure on prices.”

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