Due to sharply rising oil prices, strong 30-day contract prices for May and a greater than expected fall-off in natural gas production during the first quarter 2002, Lehman Brothers analyst Thomas Driscoll said the firm is raising its 2002/2003 natural gas price forecasts by $0.25 and $0.50 to $3.00 and $3.50 per MMBtu, respectively.

The move follows similar action taken in early April by a few other analyst houses. Based on the recent resurgence in the U.S. economy and the technical rally sparked by a surge in oil prices, Salomon Smith Barney (SSB) analyst Robert Morris and Raymond James analyst Wayne Andrews both made upward revisions in their natural gas spot price forecasts during the first week of April (see NGI, April 8).

Morris revised SSB’s 2002 composite spot natural gas price forecast to $2.85/MMBtu from $2.25/MMBtu, and for 2003 to $3.50/MMBtu from $3.00/MMBtu. On the first of April, Andrews raised Raymond James’ forecast for the second and third quarter 2002 from $2.80/MMBtu and $3.65/MMBtu to $3.50/MMBtu and $3.75/MMBtu, respectively. The increase raised Andrews’ full-year 2002 Henry Hub natural gas price forecast from $3.25/MMBtu to $3.45/MMBtu. Raymond James also introduced its 2003 price forecast of $3.75/MMBtu.

“Oil prices have helped us to survive a dangerous storage situation,” Driscoll said in Lehman Brothers’ Industry Update . “As long as the storage surplus remains substantial, we believe that natural gas prices will be limited by the threat to natural gas demand that is posed by fuel-switchable customers, especially by those customers that can switch to residual fuel oil.”

The analyst pointed out that high natural gas prices a year ago forced customers to substitute residual fuel oil for 1.0-1.5 Bcf/d of gas. “Several months ago we had feared that a springtime oil price of $19-20 could ‘cap’ natural gas prices at $2.00-2.50,” Driscoll said. “We continue to believe that natural gas prices will be limited by residual fuel oil prices over the next six months. If crude oil were to fall into the low $20 range, we believe that natural gas prices could be forced down into the mid $2 range.”

He added that the dynamics could very well change going into winter: a tighter natural gas market could allow gas producers to achieve selling prices higher than residual fuel oil parity if the market tightens by more than 1-1.5 Bcf/d. According to Driscoll, the two near-term risks to the natural gas price are lower oil prices and falling natural gas demand. Rising natural gas prices appear to have led to a 3-4 bcf/d decline in demand over the past several weeks.

As for gas production, the analyst said that Q1 production may have fallen 2.75% from Q4 levels. “The sharp fall in Q1 production estimates (companies that produce about 40% of U.S. gas volumes have reported quarterly results) follows a modest 0.6% production decline in Q4 and a sharper 1.4% decline in Q3,” he said. “Although a large portion of the production decline was a result of the steep decline in spot gas prices and the strong economic incentives to cut back, particularly sharply on high-rate and rate-acceleration drilling, we are surprised by the magnitude of the decline.”

Going forward, he said that the production decline will “likely flatten somewhat” over the rest of the year, but he now is forecasting a full-year production decline of 4.0-4.5% versus the previous forecast of a 3% production decline in 2002. “On a preliminary basis, we expect 2003 production to fall 2.0-2.5%.”

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