Earlier estimates that North American E&Ps would boost their budgets in 2003 as much as 20% were about 5% too optimistic, because producers continue to be concerned about near-term natural gas prices, surplus gas storage and a lack of drilling prospects, according to research by RBC Capital Markets.

In RBC’s latest “Research Comment on Oil & Gas Drilling,” analysts revised their spending increases by E&Ps to 15% in 2003 after analyzing the first six months of this year. RBC estimated that eight of the large E&P companies went over budget in the first six months of this year, reinvesting more than 100% of their discretionary cash flow and giving them little wiggle room through the rest of 2002. However, producers also lack confidence in near-term gas prices, remain concerned about surplus gas storage heading into the shoulder months — and, there are fewer economic drilling prospects.

Regarding gas prices, analysts estimated that “natural gas could rise to $4.00/Mcf…without altering industrial demand dynamics”– assuming no changes in crude oil prices, which are estimated to be about $25/bbl, excluding any war effects.

“We believe the 2003 economic environment will be the key driver for natural gas with [gross domestic production] growth of 2.5% the key benchmark.” Analysts noted that during the “natural gas bubble years of 1992-1995, gas prices averaged $1.69/Mcf. During the transition years of 1996-99, prices averaged $2.23/Mcf. Since 2000, natural gas has averaged $3.68/Mcf.”

Although E&Ps are concerned about high gas storage inventory, RBC analysts believe higher levels going forward will prevail. “Using the futures market as a proxy, it appears the natural gas market is in balance, despite consensus concerns about storage levels. In our view, the supply/demand structure of the natural gas industry has tightened substantially since the beginning of the 1990s. As such, we think the natural gas five-year inventory range will shift higher over time, and the 2002 inventory level will be the mid-point of the new range.”

E&Ps also have “run short of economic drilling opportunities at current price levels, suggesting a need for $4.00 natural gas,” RBC noted. The third quarter will show “modest improvement,” followed by a flat fourth quarter. Pricing trends for those six months remains stable, said analysts. In the Gulf of Mexico, “no real changes in overall activity” are expected through the year, with “deep gas well drilling…expected to remain the hot play.” Meanwhile, Canada’s third quarter will be a “literal washout due to weather,” said analysts. “E&P’s will need to play catch-up” in the final three months of this year.

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