The only thing John Olson, energy analyst for Sanders Morris andMundy, needed yesterday following his speech at a producers’conference on gas supply and demand at the Canadian embassy inWashington, D.C., was a producer to volunteer to step up on stageand be slapped around.

If there was even a smidgen of doubt that producers are headedin the wrong direction following a quarter with huge financiallosses, including about $4 billion in asset write-downs, Olsonclearly erased it. His speech, titled “Gas Supply? What GasSupply?” sounded like a half-hour tirade by a teacher handing outFs to the entire class.

“I am like the fox in the hen house,” he said. “I want to showyou what Wall Street is really looking for out there,” and it’sclearly the opposite of what you’re doing, he explained.

Olson noted the industry is in “crisis mode,” has been sincelast November, and probably will stay “in the ditch” for some time.It’s time for some significant changes to take place. “I don’t meanto be overly negative,” he said, insisting he’s “bullish on thisbusiness. But it depends on how you reinvent the system over time.”The industry cannot stay on the path that it currently is onbecause it diverges so completely from the direction everyone –including Wall Street, the government and consumers – expects it tofollow.

The current situation for producers is a far cry from good, henoted, reciting a rather long list of negatives. The averageE&P stock price was down 41% in 1998. The average producerearned nothing and may do the same in 1999. There were billions ofdollars in year-end ceiling test write downs on producing assets.In fact, many producers now are working for the banks, selling offassets to pay down notes. Most production is unhedged and notflowing under long-term contracts. U.S. producers have lost 14% ofthe domestic gas market to Canadian producers. Drilling budgets for1999 are down 25-30% at a time when well decline rates are5-20%/year. To top it all off, 50,000-75,000 out of a total of477,000 stripper wells are being shut in, possibly for good.

Meanwhile, the government is expecting 3% annual growth inproduction and 27 Tcf/year in gas production by 2020 from only 19Tcf last year. “I don’t have a clue where you are going to get 8Tcf/year,” said Olson.

Producers have to reinvent the business, he said. One thing thatclearly will not work anymore is the traditional netback modelwhere producers live “hand-to-mouth in the spot markets, takingwhatever prices are left over in the value chain.” Part of thereason the Canadian producers have been able to capture 14% of theU.S. market from only 6% in 1986 was their willingness to signlong-term agreements with Northeast cogenerators. U.S. producershave something to learn from that. And more buyers seem eager tohelp them by offering to prepay long-term agreements.

“You have to protect yourselves in situations like this. That’swhat Wall Street is really looking for: [companies] with locked inlong-term contracts with hedges.” He called on producers to”maximize contract bullet proofing [with more] indexing, swaps androlling hedges.”

Another key strategy for the future for producers will be tocapture more of the value chain, said Olson. Move mid- anddownstream. Invest in cogens. There couldn’t be a better time for aproducers to invest in the gas-fired power business and sign-morelong-term agreements with end-use markets, particularly powergeneration, he said.

For independent producers, many of whom probably won’t be aroundmuch longer, Olson provided a “1999 Unofficial Game Plan”:

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