Raymond James bumped down its natural gas price forecasts for the third and fourth quarter, and also dropped its gas price forecast for 2004 to $5.50 from $6.00/Mcf after analysts reviewed recent trends in U.S. fuel switching thresholds. Linking oil and gas pricing for the past several years, analysts said they now have enough data to more accurately predict how high prices have to go before “meaningful” fuel switching-related demand destruction begins to occur.

“It now appears that fuel switching-related gas demand destruction begins to occur at the traditional 6:1 Btu parity,” when oil is $30/bbl and gas is $5/Mcf, said analysts J. Marshall Adkins and James. M. Rollyson. “As more gas demand is squeezed out of the system, the oil-to-gas switching ratio gradually trends toward a 4:1 relationship,” with a reasonable mid-point of 5:1, which would drop ’04 U.S. gas prices 50 cents.

“Given our falling supply outlook, we are assuming a similar gas market story and assuming a reasonable average ratio for 2004 of above 5:1 but less than 6:1. Based on $28/bbl crude prices, this comes out to our new 2004 average gas price forecast of $5.50/Mcf.”

Raymond James also adjusted its third and fourth quarter estimates for this year. “Third quarter bid-week results are in, and it looks like prices averaged roughly $5/Mcf during the quarter. This is about $0.25/Mcf below our prior forecast. Additionally, based on our call last week that natural gas prices could suffer in September due to higher injections, it appears likely that at least the October natural gas contract will close out in late September around the mid-$4/Mcf level.”

Without an early cold spell to drive November or December gas above $7/Mcf, “our prior $6/Mcf fourth quarter forecast isn’t very likely to happen,” and analysts lowered it to $5.25/Mcf.

The oil-to-gas ratio declines during periods of gas demand destruction, like the 2000/01 winter and year-to-date 2003, said the analysts. “When the gas market is oversupplied, as it was in late 2001, this ratio heads well above the 6:1 scale. Our research suggests that in reality, the fuel switching ratio tends to move along a graduated scale, depending on how much demand is (or needs to be) knocked out of the system.”

Extreme periods of gas market imbalances tend to occur during the high demand peaks in winter, they noted. Two of the last three winter seasons “have seen the realized fuel switching ratio for residual fuel oil fall well below the Btu equivalent ratio of 6.3:1. The more recent winter data suggest the best ratio currently is somewhere between 5:1 and 6:1.

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