Salomon Smith Barney (SSB) analysts calculate that theunprecedented price surge this winter drove a significant amountmore demand out of the market than previously envisioned. With therecent decline in prices, however, some of that lost demand isreturning to the market.

SSB said its storage and deliverability models indicate therewas 3 Bcf/d of lost demand by early January because of fuelswitching and plant closings, but that figure jumped to as much as8 Bcf/d by mid-January. With the return to near parity for gas andfuel oil/distillate prices, the extent of the demand reduction haswaned to no more than 5 Bcf/d, SSB analysts said.

“If the current level of fuel switching/industrial plantclosures/conservation/liquids stripping is unchanged whiletemperatures match the 10-year average for the remainder of thiswinter, storage levels are projected to exit March near 800 Bcf,compared with just over 1,000 Bcf last year at the end of thetraditional withdrawal season.”

This would put storage operators in the position of having to”scramble” even harder than last year to refill storage through thesummer, SSB analysts note. However, the task is significantly lessdaunting than previously predicted and could be even easier ifdomestic production comes in greater than expected and U.S.economic growth slows significantly in 2001.

The other unknown factor is the weather. SSB meteorologists sayit is still unclear whether arctic air masses will begin toencroach on the Lower 48. However a major warming trend is unlikelygiven the absence of La Nina conditions.

Gas prices seemed to have bottomed out at just under $6/MMBtu asthey returned to near-parity with fuel oil/distillate prices. “Akey point here is that crude oil prices appear to have more of anear-term affect on natural gas prices than most had originallyanticipated.”

“We continue to believe that natural gas prices will remainrelatively strong for an extended period and that our full-year$5.00/MMBtu composite spot forecast is more likely conservativethan aggressive.”

SSB analysts’ latest prediction on gas supply shows productionup 0.8% in the fourth quarter relative to the third quarter of2000. “Our models reveal a slightly higher uptick of closer to1.0%. However, our models do not attempt to adjust forinterruptions due to operational problems such as wellheadfreeze-offs, which were reported by many producers in theMidcontinent and Rocky Mountain regions during November andDecember.”

The larger debate is how much domestic production will rise in2001 in response to the sharp rise in drilling activity over thepast 12 months. SSB previously postulated that production wouldrise by more than 5.0% this year after dropping around 3.0% in2000. “However, based on our recent analysis of major emergingplays such as the East Texas Bossier sand play, it now appears thatannual production added per active rig has dropped off much moresharply than we had originally anticipated. Therefore, we nowbelieve that domestic production will rise less than 5% in 2001 andperhaps closer to 3.0%.”

If production grows 5% this year and GDP growth is 2.5%, SSBanalysts predict storage levels will exceed the 2,800 Bcf level atthe beginning of November by as much as 100 Bcf. If productiongrows only 3%, storage levels would likely come up well short of2,800 Bcf with 2.5% GDP growth. “Overall, it appears likely thatthe ‘heat’ will remain on natural gas prices throughout 2001 asstorage levels remain in the spotlight.”

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