The steep gas production declines that occurred in the first quarter apparently did not continue in the second quarter, according to a preliminary survey of producer forecasts by Lehman Brothers. The survey of 45 producers indicates that production in the Lower 48 states will be roughly flat with first quarter levels, said Lehman analyst Thomas Driscoll, who believes producers have been quicker to respond to price signals since the sharp price spikes in 2000.

“We expect Q2-2002 production to be about 5% below 2001 levels, and we expect full year volumes to fall an average of 4.5-5.25% versus 2001,” Driscoll said. However the flattening in production has led to larger storage injections despite the current high levels of working gas already in storage, he added.

“How do we explain a potential flattening in U.S. gas production following estimated production declines of 1.4%, 0.9% and 2.9% over the past three quarters? We think that the major factor driving the change in production performance has been the changed incentives to producers to deliver near-term production. The sharp rise in prices in mid-2000 provided producers with a huge incentive to focus on near-term production — this was followed by a sharp fall in prices that severely reduced the incentive to deliver near-term production. It appears that oil and gas companies have responded to those incentives,” Driscoll said.

He said production decline rates over the past three quarters were “well above the trend line.” When spot prices rose in 2000, producers had to shift to projects with shorter reserve life to capture the higher prices. The acceleration drilling led to more rapid decline rates in subsequent quarters. Then the incentive to drill “high-rate” wells evaporated in 2001 with the fall in prices and producers turned to more longer-lived wells. “We do not believe that it was a coincidence that the fall in the incentive to deliver near-term production coincided with sharply lower production,” said Driscoll.

He noted that in 2Q01 bidweek prices averaged $4.67, while in 2Q02 they have averaged only $2.57. The fall in prices led producers to shift money away from “the search for production towards the search for reserves.” As prices rose about $1/MMBtu in the second quarter of this year from the first quarter, the incentive to deliver near-term volumes returned.

Driscoll said the industry needs to “recapture 2.6-3.2 Bcf/d of lost demand” to end the storage injection season on Oct. 30 at the traditional 3 Tcf level. Currently, the industry is on track to fill storage above full capacity at about 3.4-3.5 Tcf. “This will require a reduction in supply or an increase in natural gas demand,” he said. We believe that natural gas prices are likely to fall below $3 in order to recapture some of the demand that has been lost over the past several months.”

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