Higher natural gas prices aside, North American natural gas production most likely will continue its decline this year, according to some industry analysts. Even though U.S. and Canadian exploration and production (E&P) companies may raise their spending as discretionary income grows, the ramp up most likely won’t occur before the second half of the year.

If production does fall this year, it will be on the heels of a total North American decline of 4% in 2002, according to analyst Thomas Driscoll. The Lehman Brothers oil and gas analyst estimates that first quarter North American natural gas production “will be roughly flat” with 4Q02 volumes, which had fallen 1.7% sequentially and 5% from 4Q01 levels. Overall, he said, 2003 gas production volumes are expected to fall 1-3% in the United States and 2-4% in Canada.

“We believe that a 1-4% North American gas volume decline in 2003 will keep upward pressure on prices,” he said. “In the long run, rapidly rising imports of liquefied natural gas (LNG) could help plug the gap. However, the intermediate term outlook is for declining supply and strong natural gas prices.”

Ronald J. Barone, managing director of UBS Warburg, said “a key issue is that the United States has a very serious natural gas supply situation right now.” Barone noted that deliverability in the United States last year declined by more than 5% and, “given budgets and the rig count to date, I believe it will decline by another 1-2% this year in the Lower 48 states,” he said.

Driscoll said the 45 companies he follows reported a 6.4% drop in total production last year, with only 14 companies reporting higher domestic production rates. Few of the larger independents showed gains, and only one major, Shell, was up 5%. Among independents, Pioneer Natural Resources’ production was up 28% year-over-year from 2001, and XTO Energy was up 21%, but they were the only two in Lehman’s survey that surpassed the 20% mark. EnCana scored a 95% production increase year-over-year on acquisitions from El Paso Corp. and Williams.

The only other production gainers among those operating in the Lower 48 were Pogo Producing (15%), Spinnaker (13%), Dominion (11%), Houston Exploration (11%), Chesapeake (9%), Kerr McGee (8%), Ocean Energy (8%) and EOG Resources (2%). Stone Energy had flat production year-over-year.

Meanwhile, there were many double-digit losers, with independent Swift Energy topping the list with a 42% drop in production. Other companies making the list in terms of production losses included Murphy Oil (-31%), ATP Oil (-29%), Vintage (-24%), Unocal (-23%), Apache (-22%), Nexen (-19%) and National Fuel (-19%). Among the majors, ChevronTexaco’s production was off 13%, while ExxonMobil’s was down 12%.

For the first quarter, Lehman analysts expect the gas production struggle to continue in North America, forecasting a flat rate compared with 4Q02 volumes. “We expect 1Q03 North American natural gas production volumes will be about 3% below year-earlier levels,” Driscoll said. The analyst said U.S. volumes in the quarter actually will rise up to 1.25% over the fourth quarter, but Canadian volumes are forecast to fall 1-2%. (The U.S. comparison is versus a 4Q level that included hurricane-related production shut-ins.)

Meanwhile, some companies, especially some of the smaller independents with less overhead, expect to ramp up production this year, including Houston-based Ultra Petroleum Corp. The junior independent, with assets concentrated in the Rockies, increased its production levels 25% last year and improved its proved reserves by 50%.

“The 2002 growth targets I set for Ultra last year included increasing production 25% and proved reserves 50%,” said Michael D. Watford, Ultra’s CEO. “We exceeded both of these targets, significantly increasing production 43% to 17.4 Bcfe and growing proved reserves 58% to 700.5 Bcfe. All reserve and production growth came from our Wyoming properties alone. While maintaining our excellent cost structure, we are planning to grow proved reserves 25% and production by 38% to 24 Bcfe in 2003.”

In Canada, service companies also expect to make up for work that had been cut back last year. High oil and gas prices in the first quarter improved the drilling rig count there by 68% over a year ago.

“As far as the second quarter looks, it looks quite strong right now,” said Bob Geddes, vice president of drilling for Ensign Resource Service Group Inc. “This year we are expecting a very strong May and June in southern Alberta on shallow gas projects.”

What could hold back more drilling could be qualified personnel, however. Precision Drilling Corp., another Canadian-based driller, ran 70 of its 225 rigs with only two crews of five workers per rig instead of the usual three crews per rig. “We needed another 350 employees,” said Dale Tremblay, Precision’s CFO. Normally, Precision’s spring and summer is slow, but Tremblay does not expect that this year.

“We know it’s going to stay steady,” he said. “Producers are going to try and get out of the breakup and be moving as fast as possible. It’s looking very strong through the summer.”

U.S. offshore drilling activity also is expected to recover by the second half of the year, according to Jefferies & Co. Inc. Analyst S. Magnus Fyhr, who covers oil services, said the recovery would be driven by “firm commodity prices and declining domestic natural gas production,” which in turn would “stimulate and increase in natural gas drilling activity.”

Fyhr noted that E&Ps had been focused on reducing their debt, but said that the sustained gas prices “should fuel a significant increase in drilling activity by the second half of 2003 and (in) 2004, as operators are likely to reinvest free cash flow into the drillbit.”

The analyst said that the demand for premium jack up rigs is “strong,” with utilization close to 92% compared with 61% for commodity-type jack ups. “As the reserve size in the shallow water Gulf [of Mexico] continues to get smaller, we expect demand for premium jack ups to remain strong, as operators search for new production in more nonconventional niche markets.”

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