They may vary on their conclusions by about half a percentage point, but Lehman Brothers and Raymond James analysts agree in new energy research reports that 3Q North American natural gas production continued to decline year-over-year despite an upsurge in drilling activity.

Raymond James’ analysts Wayne Andrews and Jeffrey L. Mobley surveyed 46 publicly traded U.S. producers and found overall a 3.3% year-over-year gas output decline. “The key point remains simple,” they said. “As before, we see no significant near-term catalysts to alter the decline gas supply picture. Despite a 46% increase in the gas rig count over the past 24 months, gas supply continues to fall.”

Andrews and Mobley said that given the inherent rate of decline in U.S. gas wells, “combined with what is still a muted response to drilling activity, we expect domestic gas production levels to continue trending south for the next several quarters.” If oil prices remain near the $50/bbl level, “this would imply fair value for gas above $8.50/Mcf.”

Raymond James’ survey “means price rationing remains the only viable option to bring the gas market into equilibrium. With the 12-month futures strip staying above $5/Mcf in all of 2004 and setting an all-time intraday high of $8.31/Mcf last month, we belive commodity market pricing reflects the tight supply environment — even if the equity markets (and most energy analysts) have yet to fully awaken to this reality.”

The survey found that U.S. gas production fell not only year-over-year but also 1.4% sequentially from 2Q2004. However, even though the data suggest that the decline rate is accelerating, “we would caution that there is heavy volatility in these year-over-year numbers. Production in 3Q and 4Q, for example, is affected by Hurricane Ivan.”

The Raymond James analysts noted that the major producers and gas utilities had the biggest decline in natural gas production, while the independents drove nearly all of the 3Q drilling activity increases — with little production response to show for it.

“Specifically, the independents have been responsible for putting an additional 45 gas rigs to work (a 15% increase) since September 2003, and yet their corresponding production grew only 1.8% year-over-year and 0.5% on a sequential basis (compared to the 2Q sequential increase of 2.3%).” As a group, said the analysts, “They have not bee able to ‘move the needle’ on U.S. gas supply.”

Only a handful of independents kept the overall group from posting substantial declines, said Raymond James’ analysts. “Without the large organic increases in production from Chesapeake Energy, EnCana Corp. and Ultra Petroleum, the E&P group’s year-over-year growth rate would not have been 1.8% but rather a negative 0.1%.”

Lehman Brothers’ Thomas Driscoll surveyed 45 North American oil and gas producers, which account for about 70% of U.S. and Canadian gas production volumes. The analyst estimates overall North American production fell about 2.7% in 3Q2004 versus 3Q2003, with a 4% decrease in the United States and a 1.2% increase in Canada. The shut-ins from Hurricane Ivan reduced U.S. gas production by about 0.3 Bcf/d.

“We estimate that full year 2004 natural gas production volumes are expected to fall about 4.2% in the U.S. and increase about 1.2% in Canada,” Driscoll said.

Declining U.S. production has been mitigated by rising imports of liquefied natural gas (LNG) and rising gas imports from Canada. “However, our overall supply estimates indicate that U.S. gas consumption will need to fall 1.9% in 2004 for supply and demand to be in balance. We expect continued strong prices as a result.”

On estimates for U.S. supply, Driscoll said that overall, it fell 6.2% in 2003 and “will decrease an additional 1.9% in 2004. We believe that the 6.2% decline in supply in 2003 necessitated a 6.2% decline in demand — the two-thirds increase in natural gas prices from 2002 to 2003 induced consumers to reduce gas consumption. The 1.9% decline in supply/demand that we expect in 2004 has helped to support prices this year.”

Driscoll noted that the Lehman estimate contrasts with an October 2004 update by the Energy Information Administration’s (EIA) Short-term Energy Outlook, which forecast no change in overall supply in 2004 versus 2003. Lehman’s estimates are based on its own data from 2003 onwards, but it now uses EIA data between 1998-2002.

“Our estimated production data is somewhat lower than the Department of Energy data, but we believe that investors should focus more on the production trends than on the absolute level of estimated production,” Driscoll noted.

Andrews and Mobley also questioned data by the EIA showing U.S. gas production declining at a much slower rate than the Raymond James survey. EIA data for the first eight months of 2004 continues to be revised, they noted, but it now shows a year-over-year production decline of only 1% for the entire industry.

“Though certainly more believable than EIA data showing a production rise in 2003, even this conclusion seems doubtful when one considers that our surveys cover 46 of the largest gas producers in the U.S., representing 50% of total domestic production. The other 50% would have to be up 1.3% in order for the EIA data to hold! Such a level of growth from the small, mostly privately held, producers outside our survey may not be doable.”

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