Following recent movement by some of their peers, top industry analysts with Salomon Smith Barney (SSB) and Merrill Lynch downgraded their 2002 forecasts for several U.S. exploration and production (E&P) company stocks late last week. SSB’s Robert Morris also decided to lower his natural gas price forecast for 2002, while Merrill Lynch’s Donato Eassey stuck to his gas price projections.

The near-term risk of more natural gas price erosion due to mild temperatures, a weakened economy and increased gas production across the nation led analysts with Lehman Brothers, ABN-AMRO and Simmons & Co. International to lower their 2002 forecasts for several U.S. exploration and production company stocks earlier last week. Many of the same analysts also decided yet again to lower their respective 2001 and 2002 natural gas price outlooks.

The four investment analyst firms which changed their forecasts over the last week posted new average spot targets for 2002 ranging between $3.00/MMBtu and $3.75/MMBtu. That compared with their old estimates, which came in between $3.75 and $4.20. Merrill Lynch maintained its $4.25 outlook.

Morris of SSB said due “primarily to the demand side of the equation remaining more subdued” than originally anticipated it lowered its full year 2002 composite spot gas price forecast to $3.25/MMBtu from $3.75/MMBtu.

“Although a rebound in the economy could put economic growth ahead of North American production growth in 2002, the stage is already being set for storage levels over the next 12-18 months to likely preclude composite spot natural gas prices from averaging much more than $3.25/MMBtu,” Morris said in an SSB “Industry Note.”

Eassey broke from the forecast reducing trend in Merrill Lynch’s “Natural Gas Weekly Perspectives.” He said that the company remains comfortable with its Henry Hub price projection of $5.00/Mcf in 2001 and $4.25/Mcf in 2002, despite Henry Hub spot prices falling 19.2% to $2.98/MMBtu vs. $3.69/MMBtu the week prior. He said that even though gas prices are currently under downward pressure, residual fuel prices in the $3.25/MMBtu range should provide “resistance to lower prices as fuel switching economics now favor gas for the first time in 12 months.”

SSB’s Morris said that the “road ahead for E&P shares still appears rough at this juncture” due to the year-over-year gas storage surplus. He said while SSB continues to see “at least 3.5% domestic natural gas production growth this year,” demand has not returned at the levels it previously expected. Due to these factors, Morris said he believes storage levels will reach at least 3.1 Tcf by the start of winter compared with under 2.75 Tcf last year.

“Consequently, composite spot gas prices are not likely to be much over $3.00/MMBtu this fall and in the worst case scenario could approach $2.50/MMBtu, in our opinion,” Morris said.

Regarding Morris’ valuations on his coverage group, if spot gas and WTI spot crude oil prices are $3.25/MMBtu and $22.00/bbl, respectively, then Morris estimates that the upside over the next 12-18 months, on average, for SSB’s coverage group is around 20%. However, if gas and oil prices fall to $2.75/MMBtu and $20.00/bbl, then the downside would appear to be around 20% on its coverage group.

With SSB’s E&P composite currently off approximately 15% on the year, Morris said falling gas prices are to blame. The only catalyst’s Morris said he sees are an extended heat wave across the country or a sharp rebound in the nation’s economy. “The biggest culprit underscoring the recent performance in E&P shares has been the collapse in composite spot natural gas prices, which broke the $3.50/MMBtu psychological barrier and ended the month [June] just under $3.15/MMBtu,” Morris said in the update.

As for Eassey of Merrill Lynch, he remains slightly more positive than the rest of the pack about the future. He said that while he understands that current prices will generate some downward earnings pressure on the universe Merrill Lynch covers, it will be “relatively minimal.” Eassey said that his group’s utility and merchant diversification provides a “shock-absorbing” function for the E&P units.

Eassey said several factors have “conspired” throughout the second quarter to drive record levels of storage injections over the past three months, and drive down gas prices, from $5/Mcf in early April to $2.98 on Friday. “Understandably, the downturn in commodity prices has clearly increased investor apprehension,” he said.

Labeling the long-term bullish gas cycle as continuing to remain “fundamentally intact,” Eassey said in the near-term the more commodity-sensitive companies in its universe could remain under pressure through October if hot summer weather fails to develop. “Nonetheless, we believe substantial value exists at current levels,” the Merrill Lynch analyst said.

ABN-AMRO reported earlier last week (see Daily GPI, July 5) that it was lowering its estimate of 2002 gas prices to $3.75/Mcf from $4.20/Mcf, but noted the new level “still represents a lofty and highly profitable commodity price for E&P companies.”

Due to the large early season natural gas storage injections and the continued gas demand weakness in the industrial sector, analyst David Pursell of Simmons & Co. International also reported earlier last week (see Daily GPI, July 3) that he was revising the company’s 2001 and 2002 price forecasts lower. For full year 2001, Pursell said he was lowering its outlook from $5.00/Mcf to $4.27/Mcf. He added that the company is also lowering its 2002 forecast from $4.20/Mcf to $3.50/Mcf.

Meanwhile, Lehman Brothers’ Thomas Driscoll said he was lowering his 2002 and 2003 forecasts to $3/MMBtu, versus the previous forecast of $4/MMBtu in 2002 and $3.50/MMBtu in 2003. He also lowered the 2001 forecast for the rest of the year to $3/MMBtu, down from $4.10-$4.15/MMBtu (see Daily GPI, July 5).

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