Better get used to high gas prices, say Lehman Brothers andSalomon Smith Barney, because $3.50/MMBtu is likely to be the normfor a while. In a research note, Robert Morris, Salomon SmithBarney’s energy analyst, said he expects prices to average $3.50during the third quarter and $3.75 during the fourth quarter ofthis year. Meanwhile, Richard Gross, senior vice president ofLehman Brothers Energy Research, said he expects Henry Hub priceswill average $3.30 this year and $3.35 in 2001.

In his report last week, Morris raised his full-year 2000composite spot gas price forecast to $3.25/MMBtu from $2.78/MMBtuand his full-year 2001 forecast to $3.25/MMBtu from $2.65/MMBtu.Furthermore, he cautioned that the forecast could be tooconservative.

“Importantly, we expect deliverability to be off at least 1Bcf/d this summer compared with last year. This is based on a,perhaps aggressive, assumption that the domestic natural gas rigcount expands to 700 by November (the domestic natural gas rigcount is currently 634). In addition, our analysis indicates thatthe domestic gas rig count would have to rise above 800 just toreturn domestic deliverability to where it stood at the beginningof 1999. In the interim, we expect the demand to increase due tocontinued economic expansion and the start up of new gas-firedelectric generating capacity. Also, we don’t expect much help fromCanada this year with the fundamentals and storage outlook similarto the U.S.”

Meanwhile, Lehman Brothers’ Gross said the industry simply”can’t fill storage and meet power needs this summer. We’re goingto get pretty high prices and we aren’t going to get storagefilled,” Gross said yesterday in an interview with NGI. “As aresult, we are going to have $3.25/MMBtu gas this year (averagewellhead price) and $3.35 next year and if we’re wrong these pricesare too low.”

Gross, who spoke to the mid-year meeting of the IndependentPetroleum Association last week, said he expects to see 2,600 Bcfof gas in storage on Nov. 1 if the industry just matches theinjection pace of 1999 over the same period. “We’ve run about 2.2Bcf/d less [than that] season to date. We’ve got about 20% of theseason complete. The big fill – whether we make or break the year— is probably the next four or five weeks,” he said. “Once we getinto the cooling season, it’s going to be tougher to get some ofthe big [injection] numbers. We’ll get another crack at it inSeptember and October, depending on what kind of weather we get.But so far, the early returns show it will be a struggle to meetboth markets.”

Gross noted that last winter the industry relied more heavily onstorage for supply than in recent years because of a decline inwellhead deliverability. Although wellhead deliverability probablywill improve some by next winter, the reliance on storage still isexpected to be significant. “If you look at the draw per degree dayin the last five years, it goes from about 0.35 Bcf per degree daydraw to 0.50 Bcf, 0.55 Bcf and to last year when it was 0.64 Bcfper degree day. For each degree day we get, even if it’s gettingwarmer and warmer, we are utilizing storage more to supplementwellhead supply. I don’t think normalized is 0.64 Bcf per degreeday; I think it’s probably in the high 0.50s Bcf. It’s becausewe’ve been short [wellhead supply]. We basically lived off ofstorage in 1999; that’s how we balanced the market. We won’t havethat luxury in 2000 and 2001.

“Every which way you twist and turn and look at the market, itjust feels tight. If you talk to the processors (Dynegy, Duke,Williams..) they’ll tell you they are still struggling a littlebit. All of these things tell us it is going to be very difficultto serve both masters this summer.”

Gross said he doesn’t expect producers to return to 1997 levelsof wellhead deliverability until 2002. “All of this is predicatedon fairly high drilling levels; for instance, the average between2000 and 2004 has to be 50% higher in drilling activity than theprevious five years. Those are big-time assumptions. We’ve got toman those rigs. We’ve got to develop those prospects. We’ll seewhere we go. I’m a firm believer in the resource base. I spent mostof my 25-year career as an E&P analyst so I’m relativelysanguine about the response. It’s just that there’s a lag, whichmakes 2000 and 2001 pretty tight.”

Another bullish factor is hydroelectric generation, which isshort this year. “If you look at past years of depressed demand,they have been very good hydro years. This year is going to bemediocre, and that’s a big swing. In California alone, from areally good year to a crummy [hydroelectric] year, it is 300 Bcf ofdemand, and in the second quarter it is probably 2 Bcf/d. It’shuge. We are seeing it right now. They have a couple of nukes downout there. Normally they would get hydro, but they aren’t gettingit this year.” He said hydroelectric generation in January was downmore than 10%.

Gross estimates that there is going to be an additional 1 Bcf/dof gas demand for power generation this summer compared to lastyear. Another noteworthy factor is that when nukes go down thisyear, the impact on the gas market likely will be greater than inyears past, he said, because the market is relying more this yearon existing nuclear power. Nuclear generation plants are operatingat much higher efficiency rates compared to years past. “The riskis that the nuke fleet doesn’t operate like champs moving forward.One breaks down, it’s a big deal; it’s 1,000 MW a pop.”

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