Record crude oil prices, continuing domestic supply concerns, rising demand from the power generation sector and limited industrial demand destruction were among the reasons UBS cited in raising its natural gas price forecast for the next couple years, as well as its “long-term equilibrium” price.

UBS now expects gas prices to average $5.60/MMBtu this year, $5.50 in 2005 and $5.00 in 2006 compared to its prior forecasts of $4.75, $4.50 and $4.50 for those periods, respectively. Its new equilibrium price is $4.75 compared to the previous $4.50.

In addition to the factors cited above, the firm also attributed the higher forecasts to growing gas exports to Mexico, low coal inventories and robust coal prices.

In the short-term, UBS analyst Ronald J. Barone noted that recent bidweek prices have “come in ahead of our expectations and there are lingering Hurricane Ivan related Gulf supply disruptions — all of which continues to place upward arithmetic pressure on our 2004 forecast.”

The UBS price forecasts for both 2005 and 2006 are in line with Wall Street consensus forecasts at $5.57 in 2005 and $5.00 in 2006. The Henry Hub equivalent of the UBS forecasts are about $5.65 in 2005 and $5.15 in 2006, Barone said.

“Lower 48 wellhead decline rates continue to accelerate at a disconcerting pace,” said Barone. “UBS estimates that average first year decline rates on U.S. producing wells increased to 29% in 2004 from 28% in 2003, 27% in 2002, 26% in 2001, 25% in 2000 and — going further back — 19% in 1995.”

Barone said UBS expects “limited improvement” in U.S. production. The firm projects a 3.1% decline this year and a 2.1% drop in 2005 despite a significant increase in drilling. The situation in Canada isn’t expected to be much better. Although production is expected to increase about 1.7% this year (up from a prior forecast of only 0.8% growth) it is expected to be flat in 2005.

UBS also now believes that crude oil prices will not return to “historically normal levels until 2007” because of supply concerns in the Gulf due to damage from Hurricane Ivan, in Saudi Arabia and in Russia, and because of ongoing political instability in Venezuela and the Middle East. UBS is forecasting the West Texas Intermediate crude oil will average $40.66/bbl this year, $34/bbl in 2005 and $30/bbl in 2006.

“Overall, we believe the high crude pricing environment will continue to limit fuel switching,” said Barone. “Currently distillate fuel is low in supply and is substantially more expensive than natural gas.” He noted that natural gas was about $4.97 and $5.23/MMBtu cheaper than distillate in New York and Gulf Coast markets, respectively, last week. “Moreover, all of the new power plants that have been built over the past few years can only burn natural gas or distillate due to design/environmental limitations.”

As for residual fuel oil, while it still remains cheaper than gas when factoring in environmental issues, the”majority of dual fuel units that are capable of burning resid ‘switched away’ from natural gas in 2002.”

Barone also said that industrial demand destruction has been limited by a rebounding economy. Some industrial users have been able to pass through higher fuel prices.

Only partially offsetting the bullish forecast is rising imports of liquefied natural gas (LNG), which have risen to 365 Bcf year to date (some analysts say nearly 500 Bcf as of September) compared to 259 over the same period in 2003 (500 Bcf for the entire year).

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