The only thing John Olson, senior energy analyst for SandersMorris and Mundy, needed last week following his speech at aproducers’ conference on gas supply and demand at the Canadianembassy in Washington, D.C., was a producer to volunteer to step upon stage and be slapped around.

If there was even a smidgen of doubt that producers are headedin the wrong direction following a quarter with huge financiallosses, Olson clearly erased it. His speech, titled “Gas Supply?What Gas Supply?” sounded like a half-hour tirade by a teacherhanding out Fs 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.

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.

The average E&ampP stock price was down 41% in 1998. The averageproducer earned nothing and may do the same in 1999. There werebillions of dollars in year-end ceiling test write-downs onproducing assets. In fact, many producers now are working for thebanks, selling off assets to pay down notes. Most production isunhedged and not flowing under long-term contracts. U.S. producershave lost 14% of the domestic gas market to Canadian producers.Drilling budgets for 1999 are down 25-30% at a time when welldecline rates are 5-20%/year. To top it all off, 50,000-75,000 outof a total of 477,000 stripper wells are being shut in, possiblyfor good.

“I don’t mean to be overly negative,” he said, insisting he’s”bullish on this business. But it depends on how you reinvent thesystem over time.” The industry cannot stay on the path that itcurrently is on because it diverges so completely from thedirection everyone-including Wall Street, the government andconsumers- – expects it to follow.

The government is expecting 3% annual growth in production and27 Tcf/year in gas production by 2020 from only 19 Tcf last year.”I don’t have a clue where you are going to get [another] 8Tcf/year,” said Olson.

Anadarko Vice President Richard J. Sharples spent half hisspeech detailing the sharp production declines in nearly everymajor Mid-Continent and Gulf Coast producing area and he held outlittle hope that the deep-water area of the Gulf of Mexico would bethe savior of lower-48 production. He agreed this is a time ofcrisis, but Sharples was somewhat more confident than Olson thatthe industry could overcome its problems without fundamentalchanges.

“This is a call to arms to producers, although they probablydon’t need another call to arms after cost management actionsthey’ve already undertaken to get through this period,” saidSharples, noting the thousands in staff reductions and $160 billionin mergers that took place in 1998. “But there are significantregulatory and legislative actions that can impact our ability tocome out of this period and add to a strong healthy industry andfuel the gas demand growth that we’d all like to fuel.

“[This] is a request that energy policy makers carefully weighthe potential impacts of their actions on the viability of the industry.” He mentioned the need for federal action allowingproducers to pay the government royalties in-kind (in production),moving electric restructuring legislation, lifting the offshoremoratorium and easing the tax burden. He also mentioned the FederalEnergy Regulatory Commission’s various notices of proposedrulemaking and inquiry as potentially helpful to producers.

Producers can’t expect the government to do the job, accordingto Olson. They have to reinvent the business themselves, includingdoing away with the traditional “netback model,” where producerslive “hand-to-mouth in the spot markets, taking whatever prices areleft over in the value chain.” Part of the reason the Canadianproducers have been able to capture 14% of the U.S. market fromonly 6% in 1986 was their willingness to sign long-term agreementswith Northeast cogenerators. U.S. producers have something to learnfrom that. And more buyers seem eager to help them by offering toprepay long-term agreements.

“You have to protect yourselves in situations like this,” hesaid. “That’s what Wall Street is really looking for:” companieswith locked in long-term contracts and hedged production. He calledon producers to “maximize contract bullet proofing [with more]indexing, swaps and rolling 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. “You may be in the wrong business oryou may not be in all of the businesses you should be in.” Therecouldn’t be a better time for a producers to invest in thegas-fired power business and sign-more long-term agreements withend-use markets, particularly power generation, he said. “That’swhere the money is, ladies and gentlemen.”

The Department of Energy is forecasting the need for 383gigawatts of total new power generating capacity by 2020 and 90% ofthat will be gas-fired. Even being very conservative, thattranslates into 16 Bcf/d of incremental gas demand. “This is wherethe E&ampP industry is likely to have its best and brightest hopeto make a massive comeback over the next 10-12 years,” said Olson.Power plant developers “need you more than you need them. You maybe down at rock bottom with a smile on your face and a shine onyour shoe, but they need you.

“I think this is going to be the engine that drives the wholetrain of the North American exploration and production industry.There’s nothing else out there that can do it.”

Olson’s “1999 Unofficial Game Plan” for independent producers,many of whom he says probably won’t be around much longer, includesthe following: