Continued strength in oil prices, strong demand growth, limited spare capacity within OPEC and ongoing challenges to grow production and add reserves have led Lehman Brothers to once again raise oil and gas price forecasts through 2005.

Lehman analysts raised 2004 Henry Hub equivalent gas prices to $6/MMBtu from $5.25, and 2005 to $5/MMBtu from $4.75. Oil prices for 2004 were raised to $36/bbl from $32, and 2005 prices to $32/bbl from $28 (see Daily GPI, March 26).

“Although we are raising near-term expectations for oil and gas, we are continuing to value the shares on a long-term price forecast of $28/bbl for oil and $4.75 for gas,” said Thomas Driscoll and Jeffrey Robertson. “As a result, we do not expect material changes to price targets.”

In the next few weeks, the analysts also expect to revise producers’ cash flow estimates through 2005. Expectations for 2006 and beyond, however, are unchanged. “Based on a preliminary review of sensitivities of cash flow to oil and gas prices, we expect to raise 2004 cash flow estimates for the group by about $5-7 billion in 2004 (15%) and $2 billion in 2005 (5%).”

Driscoll and Robertson “continue to believe that the anticipation for continued strength in commodity prices is likely to help retain investor interest in the group.” However, they noted three risks to investing in exploration and production stocks: recent strong share-price performance, lack of adequate “attractive” re-investment opportunities for the companies, and the possibility that the continued strength in prices could lead to an increase in capital and operating costs, resulting “in disappointing levels of free cash flow and sub-optimal investment returns.”

Leverage to rising oil and gas prices “should play a role in stock selection,” said the analysts, but “we think that other factors are more important than leverage when choosing oil and gas equities.” Investors may want to focus on companies with a lot of leverage to oil prices, which they believe include Canadian Natural Resources, Nexen Energy and Occidental Petroleum. Other investment opportunities are Burlington Resources, Devon Energy, Noble Energy, Talisman Energy, XTO Energy, Chesapeake Energy, Stone Energy and Houston Exploration.

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