Lehman Brothers on Tuesday lowered its 2004 natural gas price forecast to $3.75/MMBtu from $4.25 and also lowered the longer term forecast to $3.75 from $4.00 because near-record injection levels heading into the heating season “could cause significant price weakness.”

Analyst Jeffrey Robertson said “the sustained period of high prices this summer appears to have had a very negative impact on demand, allowing for refill rates 4 Bcf/d above the five-year averages. If the demand pattern continues and weather is normal or warmer-than-normal, prices could fall below $4/MMBtu, and based on five-year heating season withdrawal patterns, storage inventories could approximate 1,400 Bcf at the end of March 2004.”

Robertson and analyst Thomas R. Driscoll noted that gas injections of 2.2 Tcf so far this refill season are nearly 40% higher than last year’s level, and injections over the past four weeks have been 4 Bcf/d higher than normal, implying very weak demand. “It’s all on the demand side,” Driscoll said during a conference call to discuss the changes.

Driscoll said the “real risk is clearly there for gas to fall to $3.50 in December.” While he added he didn’t think it would fall that much, the “real issue is warm weather this winter. There’s certainly some vulnerability there.”

The increased injection rates, said Driscoll, have been caused by weak underlying (industrial and perhaps utility) demand. “The storage pattern this year may be reminiscent of the winter of 2000-2001 when very high prices early in winter led to disappointing storage behavior/demand until gas prices retreated to the $2 level late in 2001. While we do not see a retreat…to the $2 level, we believe that it is likely that natural gas prices will fall below $4 and perhaps approach the $3 level this winter (especially if the winter is warmer than normal).”

When asked about the recent high gas prices, Driscoll noted that the market “needed high gas prices up to now, and now that we’ve fixed the storage shortfall, we don’t need high prices. That’s why we’ve seen some weakness.” He said that the gas market is “not competing as much as it has in the past” with oil markets, but he added that there have “got to be some industrial customers out there to come and balance this market.”

For mid-cap producers, Lehman’s Robertson maintained a 2-Neutral rating overall, reflecting 7% upside potential provided by the median stock in its coverage universe. “We continue to believe that companies that have used the high-price environment over the past year to improve their financial flexibility could benefit if the asset market improves. Commodity price volatility over the past year seems to have made the balance between buyer and seller expectations difficult to overcome unless the seller is able to hedge a significant portion of the proved production for the forward 18-24 months.”

Robertson noted that the revised price outlook “clearly benefits those companies with an ‘oilier’ production mix and hurts those with a ‘gassier’ production mix. On average, we are lowering our 2004 earnings per share and cash flow per share estimates by 20% and 4% respectively.”

Lehman lowered its ratings on several gas-leveraged producers to 2-Equalweight from 1-Overweight, including Burlington Resources, Devon Energy and EOG Resources. EnCana Corp. was dropped to 3-Underweight from 2-Equalweight. Only Talisman Energy was moved up to 1-Overweight from 2-Equalweight in Lehman’s producer universe.

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