August 11, 2004

According to a top industry analyst, the influx of LNG over the next few years will have a significant impact on the economics and pricing of the natural gas industry. If his assessment is correct, the imports will provide needed supply and act to lower prices.

"I expect the economics of the industry to undergo a big change with the increase in LNG imports in the next 2 to 4 years," says Stephen Smith, a Natchez, MS consultant. He said the changes will largely be seen in the Gulf of Mexico, for there are fewer environmental hassles, and depleted or depleting gas fields will be able to help provide infrastructure to support the imports.

In addition new storage is a likely by-product of increased LNG imports and it is likely to be built to make it as market responsive as possible and in alignment with the expanded import capacity. "There will be a more favorable supply demand balance (i.e. greater supplies) when this supply hits the market

in the latter half of 2006 or 2007," said Smith.

He suggested that price pressure will be slowly and steadily upward in a volatile framework with prices cresting upwards of $6. At that point market pressures should ease prices lower.

"As supplies start to become adequate in late 2006 and 2007 and prices begin to ease, there will still be volatility but additional storage will become very useful." The current storage environment looks healthy.

"It looks like the industry will easily hit 3.1 TCF by the end of October, but summer is rapidly drawing to a close, this week is a done deal with mild weather in the Northeast, the industry is down to 4 weeks before Labor Day and a bullish weather driven price scenario is running out of time," he said.

He suggested that a 3.150 TCF beginning inventory is the comfort level the industry now needs and that is higher than the 3.03 Tcf 10 year average. "Last year the industry hit 3.155 Tcf and that knocked the gas price down in late October for one week to $4.38, but at the time there were not the distillate and oil prices we have today."

"My thought is that the industry will hit the comfort level, and what the market is doing this week is finally acknowledging that summer is not happening the way it was originally anticipated. It is finally marking down the price. My estimate of the close on the September contract is $5.40," he said.

According to Smith the ten year average of beginning storage is 3.030 Tcf and there is at least a 100 Bcf adjustment that the industry would need in order to feel comfortable that supplies were adequate. "Buried in all the traders and buyers and sellers are the utilities that have to make sure the gas is there. At the end of the day these folks are the ones that determine the comfort level," he suggested.

He pointed out that the requisite comfort level has been rising and the main reason it has been rising is that when the historical storage draws during the winter are examined, there is one important difference from the past 10 years and today. "Five to eight years ago if there were an extremely cold week or two, there was excess production capacity available. Supplies were not purely a storage phenomenon, for there was shut-in capacity. There was a 'gas bubble'."

"What has happened is that is gone, so to look at historical storage change numbers as a reference, they reflect the ability of the industry to pull on that gas from extra productive capacity.

Since that excess is no longer available there needs to be extra storage going into the winter. "Whether it is 3.15 or 3.2 Tcf is difficult to say, but more is needed, somewhere in the range of 100 Bcf.

Thus the industry could dampen price volatility and lower prices by building more storage. The return on investment would be realized by lower price for natural gas.

"Those storage decisions are being made every day and firms are announcing new additions to storage. If there is the volatility present, i.e. there can be a 50 to 1.00 change in gas price in a relatively short time, and if one has the ability to soak it up when prices are 1.00 lower, having that option has value," he demonstrated.

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