Analysts are escalating their spot gas price forecasts but it’snot the oft-cited storage fill that’s driving them.

Besides the weather, “there’s a lot of uncertainty aboutproduction capacity,” said Ron Denhardt, energy services vicepresident for WEFA Inc. “It’s tight, but no one knows how tight.”The Burlington, MA-based firm is predicting Henry Hub prices -November through March – will average $3.05 per MMBtu. That’s basedon a winter that is 2% to 3% warmer than normal. “Right now theforecasts for most of the country are for warmer than normaltemperatures. If it gets colder, prices could go extremely high.”

PaineWebber also has revised its composite spot forecast fornatural gas prices upwards by eight cents to $2.20/MMBtu for theremainder of the year. This is well above the industry’s consensusof $2.08/MMBtu.

The forecast assumes August through December composite spotprice averages of $2.54, $2.40, $2.45, $2.75 and $2.80/MMBtu,respectively. But the forecast prices “could prove conservative ifthere is material Gulf of Mexico hurricane activity,” wrote analystRon J. Barone in a PaineWebber research note.

“There’s a lot of gas in storage. That’s not the problem,”Denhardt said. The comparisons showing storage lower than last yearignore the fact storage hit record levels last year. But whilestorage levels are closely tracked and measured, production isanother story.

“Our forecast is primarily based on the assumption thatproduction capacity is way down and continuing to decline. But,it’s hard to tell what’s actually happening.” Denhardt pointed outthe Energy Information Administration showed production capacityoff in the first quarter of 1999 by 2% from year ago figures. EIA’ssecond quarter report, however, showed production down justone-half percent from the second quarter 1998. “At the same timeour calculations based on company quarterly reports showedproduction down 4% from the prior year.” That’s a big difference toreconcile.

There are problems with both of those measurements, Denhardtsaid. EIA gets its data from the states and there can be glitchesin that process. The quarterly reports, however, are mostly fromlarger producers. “It could be smaller producers are doing better.We’re guessing production overall by the end of the year will bedown 4-6%, but it’s a big guessing game. There’s a question whethersmaller producers have the cash flow to increase drilling.”

Barone agreed the low level of domestic drilling activity is themain contributor to the upward movement in gas prices. He said hedidn’t expect to see a reversal in this trend anytime soon.

“…[I]independent producers are too highly leveraged, andthey’ve got to pay down debt before they can re-accelerate thedrilling program.” This pickup in drilling activity will beessential before “we start to see natural gas prices start to comedown dramatically.”

“By historical standards, we’re looking at very healthy [cash]gas prices going forward,” probably over the next 12-18 months, hetold NGI.

Barone warned the rise in gas prices could be a double-edgedsword for the gas industry. “I think it is a good thing, but toomuch of a good thing isn’t [best] for industry. Too much highprices, I think, could stop some growth,” causing gas customers,especially power generators, to switch to other types of fuels fornew facilities.

As for futures prices, “I don’t think we’re going to keepfutures at $3.06,” Barone said. We’re not going to keep numberslike that in the shoulder months. Will they come back to $2 andsome change? Yeah. Could I see $5 in certain days in January? Yes.”

The shoulder months could see some lower prices, Denhardtagreed, depending on hurricane activity. But the question goinginto the winter is how far storage can go in filling in theproduction deficit.

Susan Parker, Ellen Beswick

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