Few if any market observers a month ago predicted near-month futures prices would be approaching $3.50/MMBtu in March given the large surplus of natural gas in the nation’s storage fields and the weak economy. But it happened, and now consultants and analysts are battling over which path prices will take in the next few months. In one corner, Houston-based Simmons & Company International believes the puzzling spurt in natural gas prices is over, while in the other corner analysts at Raymond James & Associates say it’s here to stay.

Simmons predicted last week that prices will weaken in the near-term to reflect the reality of the “significant” overhang in storage. Raymond James analysts said prices will continue higher because the U.S. supply-demand balance is now tighter than the market understands, and the emergence of “normal” weather has positively impacted the U.S. storage overhang.

Simmons conceded that it doesn’t believe gas prices will tumble as low as it had predicted earlier. “Our $2.25/Mcf and $2/Mcf 2Q02 and 3Q02 price forecasts are likely too low,” given they did not account for recent climb in crude oil prices to $25/bbl, and “we will likely revise in the coming weeks,” it said in a new report, “Trying to Understand the U.S. Natural Gas Markets.”

Simmons said it based its forecast of weakening in gas prices on three assumptions: 1) crude oil prices will not move “materially higher;” 2) the Nuclear Regulatory Commission (NRC) will not mandate significant forced inspections of pressurized water reactors in the wake of the problems uncovered at First Energy’s Davis-Besse reactor in Ohio, nor will significant corrosion problems be detected at additional nuclear reactors resulting in extended downtime; and 3) the decline in off-peak spark spreads seen over the past few weeks will create less gas demand (on the margin for power generation) in late March and April, resulting in more normal gas storage injections/withdrawals during April.

The recent rise in gas prices “makes sense” in the face of strengthened crude oil prices, an improving economic outlook, declining rig count, and the potential for large-scale nuclear outages, according to Simmons. “That said, the magnitude of the price increase is puzzling, as gas storage levels remain above prior seasonal record levels.” Gas prices rose a “whopping” 54% to $3.36/Mcf during the past five weeks, it noted.

One reason for the rapid hike in gas prices recently was that the “overall outlook for long-term natural gas fundamentals is positive,” said Simmons. “Improving economic data suggests that the hope of a 2002 economic recovery is looking more like a reality, and our discussions revolve around the pace of the recovery (not if one will materialize).” In addition, the “gas-directed rig count continues to fall…setting up a situation where the fundamentals are aided by both growing demand and falling supply.” But $3.40/MMBtu is a bit excessive given the other fundamental factors affecting prices, the consultants said.

What many people fail to realize, according to Raymond James analysts, is that the supply-demand imbalance last year has “flip-flopped” with a change in the weather. The record warm weather clouded the market’s view of the “true underlying” gas supply and demand fundamentals, they said. Removing the temporary impact of weather from the picture shows a “hugely bullish swing” in supply and demand in the past five months. For most of 2001, “there was more than a 5 Bcf/d negative year-over-year swing” in U.S. demand. However, since September 2001, the situation has reversed.

Higher natural gas prices are “here to stay,” Raymond James analysts said in their latest Energy “Stat of the Week.” Their weather-adjusted data indicate that in the past two months, gas supply has declined and/or gas demand has increased by more than 5 Bcf/d versus the same week in 2001. “In other words, the natural gas supply/demand equation has tightened dramatically over the past couple of months.”

The analysts said that it “now appears that this risk of a price collapse late in the summer has been significantly reduced,” as a large amount of “storage overhang has been eaten away,” leading to a “meaningful change in U.S. natural gas fundamentals.” They believe that it “now appears winter-ending storage is likely to end up below 1,500 Bcf in the ground,” leaving the United States with “nearly full but not over full” storage by the end of summer.

The increase in storage withdrawals over the past few weeks clearly was a “catalyst for natural gas prices to increase,” Simmons agreed. “However, we believe there is a chance that the outperformance seen in the February and early March withdrawals was based on increased gas-fired power demand due to unusually high maintenance of nuclear and coal power plants.”

The high level of off-peak power prices in several NERC regions during that time period suggests that gas-fired power plants were running during both peak and off-peak periods, Simmons noted. “Off-peak spark spreads have fallen in mid-March, suggesting that gas generation has been reduced somewhat, which may partially explain the…disappointing AGA-reported 50 Bcf withdrawal” (AGA reported a 69 Bcf withdrawal last week for the week ending March 22; the 50 Bcf withdrawal was reported the week prior).

The possibility that the NRC might impose mandatory inspections (i.e., shutdowns) on nuclear power plants similar to the facility in Ohio “has created additional positive sentiment in the natural gas markets,” according to Simmons. “Although it is very difficult to handicap the outcome,” a worst-case scenario suggests that more than 5 Bcf/d of gas demand would be added if 40,000 MW out of a total of 65,000 MW were to be taken off-line, Simmons noted. This has a “very low probability” of occurring, however. But if only 8,000 MW is taken off-line, it would boost gas demand by 1 Bcf/d.

The prolonged drought in the Northeast has favorably affected gas demand and prices as well. “Negative impacts on hydroelectric generating capacity could potentially increase gas demand by 300 to 700 MMcf/d,” according to the Simmons report. The Northeast has 25,000 MW of hydro capacity.

In contrast, water levels in the West are about 85% to 95% of normal, it said. “Based on normalized hydro output, we estimated that gas demand from power would decrease by approximately 600 MMcf/d… If drought conditions develop again this summer, some of this ‘lost’ gas demand could return.”

Overall, however, Simmons believes the bearish factors far outweigh the bullish factors and prices should come tumbling down this month as the market reexamines the heavy storage overhang and shoulder month weather.

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