Despite record natural gas drilling begun in 2000 and boosted through mid-year, U.S. production may actually show a year-over-year decline by the time fourth quarter reports are released, according to energy analysts following quarterly reports by exploration and production (E&P) companies. However, in Canada, September natural gas production is up and will be up at the end of the year, putting more pressure on prices and E&P values both in the Lower 48 and Canada as pipeline capacity fills up.

“It is becoming increasingly clear to us that U.S. wellhead natural gas deliverability has not benefited from a record amount of drilling,” said analysts at FAC/Equities. “So far, third quarter 2001 production reports would indicate that U.S. wellhead supplies have not increased at all, and that there is some reason to believe that, in fact, production may have peaked the quarter prior — 2Q 2001. If this ends up being the case, and U.S. gas drilling continues to plummet, there is a good chance that U.S. supply and demand will re-balance itself by the middle of 2002. This would be positive for U.S. natural gas prices and in turn, exploration and production (E&P) stocks.”

Raymond James Energy analysts echoed those sentiments, finding in its survey that U.S. natural gas supplies are down 2% sequentially. “E&P company data suggests that U.S. natural gas production may be responding to lower prices and lower activity levels faster than many would have anticipated,” said analysts. “Furthermore, with natural declines already taking hold, fourth quarter domestic gas production will almost certainly be lower than third quarter volumes and could even show a year-over-year shortfall. As a result, natural gas will again become a supply-driven commodity with higher equilibrium prices needed to rationalize demand and balance the supply/demand equation.”

What makes the case unusual, noted Raymond James, is that historically, there has been a three-to-six month lag between a peak in the rig count and the peak in production. However, this year, production began showing declines “almost immediately” following the peak in drilling activity. “In other words, producers have been unable to generate any meaningful growth despite record levels of drilling during the past 12 months, and could begin to lose ground on a year-to-year basis as early as the fourth quarter.”

Despite the 30% increase in gas-directed drilling activity, Raymond James analysts found that third quarter production was only up less than 1% compared with the same period last year. Because of this factor, the analysts warn that “we could see a 1+% year-to-year decline in U.S. natural gas production when fourth quarter production is reported.”

At FAC/Equities, a preliminary survey indicated that U.S. production volumes may be declining 1-2%. “This is unexpected. We had been modeling a 1-2% increase.” Even though several independents and majors had not reported when FAC conducted its survey of 27 companies — holding 21.5 Bcf/d of U.S. production, or 37% of estimated U.S. wellhead deliverability — the survey shows a net decline versus the same quarter a year ago and a sequential decline versus the second quarter of 2001.

“We now must say that third quarter 2001 reports provide ‘ammo’ to the bulls,” noted FAC analysts. “We and others had optimistically forecast a 1-2% increase in U.S. wellhead deliverability by 3Q 2001; therefore, a decline, if final reports so indicate, would be bullish.” Analysts noted that if the third quarter reports “conclusively” show a decline, they are actually ahead “by a quarter or two” in their “chasing demand on down” thesis through 2002.

“We saw the U.S. gas rig count in 2002 averaging 750 rigs, causing U.S. wellhead deliverability to fall 2% by midyear 2002, and 6% by year-end 2002. With U.S. demand off 4.5% in 2001, and not expected to fall away at the same rate in 2002, this would create the likelihood of bringing North American natural gas supply/demand back into balance by midyear 2002 and potentially leading to an imbalance or tight supplies in the second half of 2002…in turn, creating a return of much higher natural gas prices.”

Meanwhile, production is up in Canada. In its latest Oil & Gas E&P report, Lehman Brothers analysts estimate that Canadian natural gas production in September increased 520 MMcf/d, or 3.6% over the same period a year ago, to 15 Bcf/d. The production level is 422 MMcf/d, or 2.7%, less than August 2001. “While the decline in September is, in part, due to ever-steepening decline curves in Canada, maintenance-related shutdowns may have also been a major contributor. With an additional 200+ MMcf/d of incremental production expected to come out of Ladyfern by year-end, we still believe that the year-over-year production gap can remain wide (possibly 1 Bcf/d or better by year-end), providing downside risk to natural gas prices and the E&P group.”

Lehman Bros. said that based on currently available data, “we estimate that takeaway capacity on the U.S. side for imported Canadian natural gas is about 10.5-11 Bcf/d. With October 2001 net exports having averaged 9.6 Bcf/d, or 87%-91% of estimated takeaway capacity, rising net natural gas exports to the U.S. could put more pressure on natural gas prices.” Based on September’s total Canadian production number, “it is our belief that the future production gain from Ladyfern could contribute to flat-to-rising Canadian production over the remainder of the year, and yield an overall year-over-year production increase in Canada of 1 Bcf/d (7.3%) or better, by year end.”

Lehman Bros. also estimated Canadian natural gas storage, finding that injections through Oct. 26 were 1.8 Bcf/d, or 0.4% Bcf/d more than 2000 and 0.3% “stronger than the four-year average.” The analysts noted that in Canada, “it appears that demand has recovered quite strongly over the past several months after a very weak start.”

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