With the expectation of falling gas prices and closer alignment of the Nymex strip with the spot market, Raymond James & Associates Inc. — which last week cut its 2008 gas price forecast to $7/Mcf from $10/Mcf (see Daily GPI, Sept. 18) — recommends that investors pursue an oil-focused strategy.

The firm said next year will mark the first negative growth year in terms of activity and pricing in more than five years.

“[W]e would suggest trading the gassy names on a short-term basis around moves in natural gas prices (i.e., the potential winter spike between now and January). From a longer-term perspective, we would invest in those energy companies that have meaningful exposure to oil-driven themes. That would include primarily companies leveraged to deepwater and international markets,” the firm said in a Monday research note.

While a weather-driven gas price surge is possible with winter’s onset, Raymond James said it expects prices to fall through the spring and late summer next year. “More importantly for energy investors, we think next year’s decline in natural gas prices will be accompanied by a corresponding decline in the gas futures ‘strip.'”

The Nymex strip drives drilling activity more than spot prices, the firm said, and futures prices were high over the last two years relative to spot prices. “Next year, we expect that the fear of surging LNG (liquefied natural gas) imports and stubbornly high U.S. gas production will force futures pricing closer to spot pricing,” Raymond Jame said.

For 2008, the firm said it expects the Nymex strip to average “well below $7/Mcf, thereby driving U.S. drilling activity lower.” The firm also noted that it is cutting its earnings outlook for many drilling and oilfield service companies with “meaningful” North American exposure. But investors shouldn’t panic.

“While we now see activity and pricing levels headed lower over the next year, we are not expecting a drilling activity meltdown such as those that occurred during the downturns in 1998/1999 and 2001/2002,” the firm said.

Looking north to Canada, Raymond James said things can’t get much worse than they have been. “After an abysmal year so far in Canada, which has witnessed a rig count decline of more than 30% year-to-date, we do not expect much additional downside to come in terms of activity levels for next year.”

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