After correcting the data for acquisitions and divestitures, U.S. natural gas production increased 1.6% sequentially, breaking a trend of lower production for the previous six consecutive quarters, according to Raymond James energy research. However, the bullish analysts were quick to point out several one-time events that contributed to the deceptively strong year-over-year production numbers.

With the one-time events clouding the production picture and the record low level of gas in storage, the analysts said they are raising their 2004 gas price forecast to $6/Mcf from $5/Mcf.

Production data hints of an improving U.S. gas supply situation, but “we remain more convinced than ever that the U.S. is facing a supply-driven chronic gas shortage scenario for the next several years,” said J. Marshall Adkins, a Raymond James energy analyst. “With our expectation of dwindling gas supplies (regardless of drilling activity), the only solution is a market induced ‘rationing’ of available natural gas through higher gas prices.”

Adkins noted that gas storage numbers for the past few months suggest that the required gas demand destruction is not occurring with mid-$5/Mcf gas prices. “That means U.S. natural gas prices must move and stay high enough to kill enough demand to re-balance the U.S. gas supply/demand equation.”

Raymond James also tweaked its 2003 quarterly gas price progression while maintaining its $6/Mcf forecast for the full year “at least for now.” Noting that its price forecast “has been well ahead of consensus,” Adkins noted that the bias “continues to remain on the high side of this estimate,” which could possibly spike gas prices as high as $7-$9/Mcf this year.

As to why first quarter production appeared to look better than it was, Adkins said there were several one-time events. “To begin with, the biggest sequential impact was the return of Gulf of Mexico production that was shut in during the fourth quarter hurricanes and tropical storms.” Raymond James estimates that the storms alone knocked out about 2% (or 1 Bcf/d) of U.S. gas production for the fourth quarter. “Clearly, these storms exaggerated both the declines in the fourth quarter as well as the increases in the first quarter.”

Also, the Canyon Express system in the Gulf continued to ramp up through the first quarter, adding about 0.5 Bcf/d of additional year-over-year gas production, said Adkins. There also was a “meaningful” price-related supply response in the quarter through natural gas liquids (NGL) stripping. The supply-related fuel switching takes place when gas prices rise faster than NGL prices, Adkins noted.

“We believe this lack of liquids stripping increased natural gas production to the tune of about 0.5 Bcf/d or about 1% of domestic production sequentially and 1.0 Bcf/d or about 2% of domestic production year-over year.”

Finally, “much lower year-over-year gas storage levels and lower pipeline pressures allowed more gas to flow into the system this year versus last year,” said the Raymond James analyst. “While it is very difficult to quantify the impact of lower system pressures, we have numerous anecdotal stories that confirm that lower system pressures allowed producers to flow more gas than last year.”

Interestingly, the majors’ production is falling faster than the independents, said Adkins. The majors increased by 1.7% relative to the fourth quarter and declined by nearly 3.3% on a year-over-year basis. However, independents were down about 0.5%, which was not a surprise. “Majors have historically been slower than independents to increase drilling activity in response to higher commodity prices.”

Going forward, Raymond James believes that the “damage to the fundamental supply story has already been done.” The recent drilling activity “is too little too late” — and “we believe 2003 production will likely be down further from the very low base of production in 2002.” Second quarter production also is likely to be down from the first quarter, with majors experiencing the biggest continued sequential and year-over-year declines. (In the disclosure statement on the last page of Raymond James’ report, it notes that the firm may make a market in the gas producer stocks mentioned in the report and may have managed or co-managed stock offerings or provided investment banking services to the companies mentioned in the report.)

Meanwhile, Thomas R. Driscoll, an energy analyst with Lehman Brothers, completed his quarterly gas production survey, covering 49 North American producers, which accounts for about 70% of U.S. and Canadian volumes. The analyst concluded that overall, North American gas production rose 0.9% sequentially and fell 2% from a year ago.

For the second quarter, Lehman Brothers estimates that North American production will be roughly flat sequentially and down 1-3% year-over-year. Overall, volumes are forecast to fall 1-3% in the United States and 2-4% in Canada.

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