Assuming U.S. natural gas prices average above $8/Mcf in 2007, every drilling rig that can work will work both onshore and offshore, Raymond James energy analysts said in a report issued last week.

The bullish energy forecast by Raymond James analysts J. Marshall Adkins and James M. Rollyson sets gas prices at around $10/Mcf in 2007. However, Adkins and Rollyson said as long as gas prices hold above $8/Mcf, “every rig that can work will be working. Under this scenario, the Baker Hughes U.S. rig count will rise by 195 rigs (or 12%) to average 1,849 total rigs in 2007.”

The analysts cautioned that their 2007 rig forecast hinges on higher average U.S. natural gas prices.

When all is said and done, the analysts expect 2006 gas prices to average around $7/Mcf. Prices at that level have “provided for profitable growth for U.S. exploration and production companies, and industry cash flows are exceeding drilling budgets. If we assume that gas prices improve modestly in 2007 to above $8/Mcf, there should be plenty of cash (and profitability) available for the industry to increase drilling expenditures by another 20% in 2007.”

However, Adkins and Rollyson said they believe “normal-weather gas fundamentals still support a $10/Mcf gas price estimate for 2007. Without getting into too much detail, our logic behind this bullish outlook for 2007 natural gas prices is based upon the following fundamentals: 1) oil prices stabilizing in the $65 to $75 range for 2007, 2) 30-year normal winter weather driving a 9% increase in weather-related gas demand, 3) substantial year-over-year price-related gas demand increases (particularly in the first half of winter), and 4) modest gas supply increases despite the sharp drilling activity increase over the past several years. While many investors still insist upon calling this a ‘weather bet,’ we think it is gas supply constraints that are more relevant to making money in energy stocks over the next several years.”

Despite a four-year surge in drilling activity, the supply response of domestic gas output “has been nonexistent,” the analysts noted. “Over the past four years, the U.S. gas rig count has roughly doubled, but gas production has not increased in any meaningful way. Even though today’s incremental production requires more wells of smaller size and tougher drilling challenges, the returns for operators remain very robust at today’s prices (more so should our commodity price forecast pan out).

“Bottom line: despite nearly a 100% increase in domestic drilling activity since 2002, domestic natural gas production remains relatively stagnant. Thus, from a supply standpoint, the industry should have the capacity to absorb more rigs without killing the cycle.”

The offshore drilling market “offers much clearer visibility into future capacity additions and worldwide drilling activity,” said the analysts. One of the “prevailing trends” within the jackup market has been international rig migration from the Gulf of Mexico to the higher-paying markets in the Middle East, West Africa and the North Sea.

Based on research, the analysts estimate that 24 jackup rigs are scheduled to leave or have already left the Gulf of Mexico in 2006. In 2007, they estimate that another 10 jackups will leave the Gulf of Mexico, which will be partially offset by reactivations of low-end cold-stacked rigs or newbuilds.” More reactivations will occur “should our commodity price forecast pan out.” In total, Raymond James is forecasting a net loss of about five rigs during 2007 from the U.S. offshore market.

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