Gas-weighted Rockies producers such as Bill Barrett Corp., Questar Corp., Ultra Petroleum and The Williams Companies face margin compression in the near term while they wait for the next increments of the Rockies Express pipeline to come online at the beginning of 2008 and mid-2009, according to Raymond James & Associates Inc.

Should Wall Street factor weaker margins into these companies’ share prices over the coming months, “we would encourage investors to capitalize on the short-sighted pullback, based on dramatically improving gas fundamentals ahead for Rockies producers in 2008,” Raymond James analysts wrote in a note last week. While investors wait for a buying opportunity Rockies gas producers have little to do but wait out the basis disconnect that set upon them earlier this year, plunging prices to below $1/Mcf during June (see NGI, June 18).

“[W]e have seen basis differentials between the Rockies (specifically Opal, WY) and Henry Hub widen substantially from normal levels of around $1.50/Mcf to extremes of over $5/Mcf,” wrote the Raymond James analysts. “This basis differential explosion…is a direct result of the pipeline capacity bottlenecks in the Rockies, along with mild weather and consequential gas-on-gas competition. Good news is on the horizon for Rockies producers, however — the start-up of the Rockies Express pipeline.”

The analysts pointed out that drilling in the Rockies is up substantially on the strength of gas prices over the last five years. This is particularly true in Wyoming and Colorado, they said; gas production is up nearly 30% since 2001.

“The Rockies accounted for nearly 20% of total U.S. gas supply at year-end 2006, up markedly from the 16% contribution only five years earlier,” the analysts said, noting that supply coming on-line, including imported volumes from Canada, exceeds the region’s needs.

Rockies pipeline infrastructure represents less than 10% of the nation’s total, the analysts said, and current takeaway capacity is only about 6.6 Bcf/d. “Clearly, this is why basis differentials have widened in the near term.”

And milder weather has caused further price deterioration in the region, dampening demand in the Rockies region and in the Pacific region curtailing demand from gas-fired power generators.

Producers should begin to see improvement in their lot with the start-up of the West segment of Rockies Express and deliveries of gas to the Midwest by the beginning of 2008. “This stage will create a significant outlet for the growing production in the Rockies, boosting the much-needed takeaway capacity from the region,” the analysts said. “The incremental 1.8 Bcf/d of takeaway capacity, an almost 30% increase from current levels, should considerably improve the gas market in the Rockies — leading to better pricing and higher profitability.

“The completion of the final phase in mid 2009, which should extend the pipeline system as far as Ohio, should drive the basis differential down even further, providing additional upside for 2009 numbers.”

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