Restricted access to capital brought on in part by the financial market’s recently-acquired aversion to anything relating to energy is holding back drilling and will contribute to a tight natural gas market over the next two years, according to Boston-based Energy Security Analysis Inc. (ESAI) in its latest North American Natural Gas Stockwatch 2-Year Outlook.

“Despite Nymex strips well above $3.00, drilling activity has failed to pick up,” says Mary Menino, senior analyst at ESAI. “We’ve been looking for a drilling response and we don’t see it.” In many cases producers are not forging ahead because their credit is restricted, either based on their own financial picture or just on the negativity surrounding energy firms right now. Lending criteria has been tightened for everyone, Menino said. Since gas prices have picked up in the last several months, the hesitation over investment really doesn’t reflect producers’ fundamentals.

Part of the problem may be that rig prices haven’t come down as much as expected, the ESAI analyst said. “Possibly they are waiting for those prices to come down further.” Also, gas prices were very low last fall, when companies were setting their budgets.

Whatever the reason, the result is an extremely tight market over the next two years, the ESAI report predicted. And a tight market means increased volatility and price spikes. Storage is in good shape, yes, but is it good enough to make up for decreased production.

“All indications are that gas production has fallen off year-on-year and that 2002 U.S. output will be down 4% to 5%,” according to ESAI. Canadian production is also expected to decline, which coupled with higher domestic demand will mean exports may drop 3% to 6%. At the same time demand has continued to grow, largely as a function of increased volumes for power generation.

While brand new power plant projects are currently being canceled due to power market conditions, ones that already are under construction are expected to be completed, either by current or future owners. Since almost all of them are gas-fired, this will increase demand.

ESAI warns that the tight gas market over the next two years will be extremely vulnerable to price spikes associated with weather extremes, lack of transmission capacity, surges in power demand and changes in oil prices. While the market is front-loaded with storage going into the winter, Menino said she is worried about how supplies are going to look from about January into next summer, as lower production eats into reserves. “We do need to see improved production.”

For more information about ESAI reports, contact Patsy Norton at 1.781.245.2036, or E-mail: pnorton@esaibos.com

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