All signs point to higher natural gas prices in early 2010, the energy team at Tudor, Pickering, Holt & Co. Securities Inc. (TPH) said Tuesday. According to TPH models, the plunge in drilling activity from the peak in 3Q2008 should result in wellhead supply declining by 5 Bcf/d, or 8%, at the end of 2009 from year-end 2008.

“The die is cast for 2010,” said TPH analysts Brian Lively, Dave Pursell and David Heikkinen. Their forecasts indicate gas wellhead supply over the second half of 2010 falling by 6.5 Bcf/d, or down 10% from year-end 2008.

Using data from nearly every producing well in the United States, the TPH analysts created a model to forecast U.S. gas supplies based on basin specifics and well production numbers. The model, said the trio, “is accurately forecasting various supply-side data points we are currently seeing in the marketplace,” including Energy Information Administration 914 data and individual well data.

“The past dictates the future…production declines will lead to a tightening gas market,” they wrote.

Based on the numbers, TPH increased its 2010 gas price forecast to $7.50/Mcf from $5.50. In 1Q2010, TPH is forecasting gas prices will average $7/Mcf, and in 2Q2010, it is forecasting gas prices to rise $1/Mcf to $8. Through the second half of 2010, gas prices are seen down slightly to average $7.50/Mcf. The 2011 gas price forecast was cut to $6.50/Mcf from $8.

By early 2010, a “much steeper” recovery is expected in oil service sector activity, with a “nice trade in gassy names,” said the TPH team. However, “beyond late 2010, U.S. activity looks flattish at 1,500 rigs with too much oil service capacity. Cycle-to-cycle earnings will be lower for North American service companies.”

The 2010 rig count is likely to increase, with oil-directed activity showing “steep increases,” according to TPH. Incremental gas activity will be focused on shale drilling.

“We are entering an environment of ‘haves’ and ‘have nots,’ with the emergence of prolific gas shales,” wrote the TPH trio. Exploration and production (E&P) “companies will be more shale focused and wary of conventional areas,” and 2010 and 2011 “are likely the gas ‘Wonder Year(s)’…”

Separately, Barclays Capital analyst Jim Crandell said U.S. E&Ps “used 59% less rigs drilling for new supply, creating the expectation that supply would do its part to equilibrate markets,” from last fall’s peak drilling to this summer’s trough. “At current levels of around 700 (where we expect the rig count to average through year-end), new production is not sufficient to offset declines from existing wells. To be clear, as the rig count has changed drastically, so too have the prospects for natural gas supply.”

The numbers are bullish, but “sustained sequential declines in production do not look likely to help gas prices climb out of the cellar until winter begins dissipating surplus gas in storage,” said Crandall. “While domestic supply looks unlikely to save 2009 prices, its effect should be felt in 2010, when production stands, on average, 3.15 Bcf/d lower year/year.”

Standard & Poor’s Ratings Services (S&P) revised its short-term working assumption for Henry Hub natural gas prices to $3.75/MMBtu through the rest of 2009 based on a “relatively tepid” production decline and on weak industrial demand.

“Because of poor industrial demand in North America and concerns about oversupply, natural gas prices have continued their downward spiral,” said S&P credit analyst Thomas Watters. “The price of crude oil, however, has surged recently, reflecting a more optimistic outlook for the global demand of transportation fuels.”

S&P’s short-term pricing assumption for West Texas Intermediate crude oil is $55/bbl through 2010, compared with previous forecasts of $45/bbl in 2009 and $50 in 2010.

“Following a period of meaningful growth in 2008, we’ve begun to see production declines in 2009 with natural gas supply in the continental U.S. declining by about 0.7 Bcf/d (or 1%) in April and May,” said Watters. “The rig count has plummeted. However, many wells that were drilled have not yet been completed. Until this backlog is worked off, production declines could remain relatively tepid.”

Weather, always a wild card, “could be a big contributing factor for the rest of 2009 natural gas prices.” However, if winter weather is mild and industrial demand remains weak, storage levels may remain “relatively high for the bulk of 2009, putting pressure on spot prices throughout the year.”

The long-term assumptions for gas reflect producers’ cost structures, production decline curves and demand growth, according to S&P.

“We believe that while some of the best shale plays can generate fair rates of the return in the range of $4-5/MMBtu, the majority of drilling opportunities in the U.S. require $6-8 prices to be worthwhile,” said Watters. In addition, the “typical decline curves for many of the unconventional resources plays, which are responsible for a high percentage of new drilling in the U.S., average 60-80%.”

Over the long term, Watters said, “demand will be influenced by the attractiveness of natural gas for electricity generation. We think that due to environmental regulations and the increase in coal prices, natural gas is likely to be the fuel of choice for additional generating capacity.”

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