Continuing weakness in the gas market due to a sharp drop indemand prompted Lehman Brothers to lower its gas price forecastsfor the first quarter and for the years 2001 and 2002. However, itmaintained its gas price forecast for 2003 and raised its crude oilprice forecasts.

Analyst Tom Driscoll dropped his wellhead forecast for the firstquarter to $5.75/MMBtu from a prior forecast of $6.25 and took 25cents off his forecast for 2002, leaving it at $4.25. His 2001annual wellhead forecast is $5.25-$5.30, and his forecast for 2003is unchanged at $3.50.

“First quarter natural gas prices — using bidweek prices asour basis — were weaker than we had previously forecast,” saidDriscoll in a research note, adding that bidweek prices were morethan $2/MMBtu less than expected. “Our estimate for the remainingnine months of the year is largely unchanged at $5.30/MMBtu. As aresult our revised full year 2001 Henry Hub gas prices forecast is$5.75/MMBtu versus a prior forecast of $6.25. We are trimming ’02estimates from $4.50 to $4.25/MMBtu but maintaining our ’03estimate of $3.50/MMBtu.”

“Natural gas demand has fallen more sharply than we expected asprices rose. High natural gas prices/limited supply/higher heatingneeds appear to have caused sharp reductions in non-heatingdemand,” said Driscoll. “Natural gas demand losses – using Q4-99 asour base – rose from an estimated 2.4 Bcf/d in early Q4-’00 to 7.5Bcf/d as gas prices approached $10 in late December and earlyJanuary. Major contributors to the demand losses were switching toresidual fuel oil, decreased natural gas plant liquids production,reduced fertilizer production and decreased industrial energydemand.”

The storage situation, however, has improved significantly, andinventories are in “much better shape than we expected,” saidDriscoll, adding that he expects storage to end the heating seasonwith 650-700 Bcf of working gas rather than prior forecasts of200-400 Bcf. “The additional demand from storage operators thissummer will be about 1.75 Bcf/d, rather than the more bullish 3-4Bcf/d that we had earlier anticipated.”

Driscoll said he also expects competitive fuel prices to keep a$5.00-5.50/MMBtu ceiling on gas prices this summer. “At this price,plant operators are likely to produce NGLs, and gas fuel users willagain burn gas in preference to distillate over the long run. Anoil price level of $20-$25/bbl would allow natural gas prices totrade in the $3.75-$4.75 per MMBtu range before becomingnon-competitive with distillate/NGL markets.”

Another factor that could have a dampening affect on gas demandthis summer is the slowing growth of the economy. The Department ofEnergy estimates that a 1% change in GDP translates into a 1.1%change in natural gas consumption. Lehman believes the relationshipis even tighter with gas being the primary fuel for powergeneration. “We believe GDP [Gross Domestic Product] growth of 0-4%in 2001 would translate into electric power growth of -1% to +3%and natural gas demand growth for power generation (including IPPs)of between a decline of 250 MMcf/d and an increase of 1.5-2.0Bcf/d.”

Regarding supply, Lehman forecasts a modest recovery this yearwith production growth of about 2%.

Rocco Canonica

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