"In a normalized weather scenario, we believe that the midpoint of U.S. natural gas will be linked to oil prices with roughly a 6:1 Btu parity price ratio," said Raymond James energy analysts J. Marshall Adkins, Wayne Andrews and Edward Minn. "Assuming Btu parity of 6:1 and our 2006 oil forecast [$58/bbl], fair value for gas in 2006 should be near $10."
Beyond 2006, Raymond James analysts expect to see "continued 1% to 2% annual declines in domestic gas production (adjusted for hurricane-related production shut-ins) for the foreseeable future, despite sizeable planned increases in drilling activity. Given a healthy U.S. economy and growing electric generation demand, we anticipate steadily rising gas demand in 2007, with price as a sole mechanism to curtail excess demand." For 2007, Raymond James has initiated a forecast of $10/Mcf through the year, which is about 28% ahead of current consensus "but in line with the futures strip."
Raymond James' full-year 2006 forecast stands at $10.50/Mcf, up from an earlier prediction of $9.25, which is about 10% ($1.75/Mcf) above First Call consensus.
Even though the 2006 and 2007 forecasts are well above the Street consensus, the 6.2:1 parity assumption in 2007 "will prove to be conservative," said the Raymond James analysts. "The longer-term crude oil and natural gas price ratio should be closer to 5.5:1, reflecting the higher costs associated with consuming heating oil equivalents, such as emissions credits."
At $50/bbl oil prices, a 5.5:1 ratio would imply a low of $9/Mcf natural gas, and at $60/bbl oil, the ratio implies gas prices above $10/Mcf. "The bottom line remains simple: the combination of falling domestic gas supply, a healthy U.S. economy and favorable fuel-switching ratios should eventually result in natural gas prices trading at or near Btu parity with petroleum liquids," said the Raymond James analysts.
In a note to clients on Tuesday, energy analyst John Gerdes said this year "could be decidedly less rewarding than it has been over the past three years." Beyond 2006, Gerdes is forecasting $8/MMBtu 2007 to 2010.
The "combination of strong growth in liquefied natural gas (LNG), weakness in industrial demand in the first half of 2006, space-heating conservation in early 2006 and the likelihood of less robust growth in gas-fired power generation demand (assuming normal summer weather versus the 10% hotter than normal 2005 injection season) imply gas prices are unlikely to exceed the $7.88/MMBtu average for 2006," Gerdes wrote. The outlook assumes normal 1Q2006 winter weather.
In Gerdes' review, current exploration and production (E&P) valuations reflect $7.75/MMBtu gas and $47/bbl oil at New York Mercantile Exchange (Nymex) prices, assuming a 12.5% return on market equity for large capital (more than $5 billion) companies.
"Given our long-term view of $8/MMBtu Nymex gas prices and $60-plus/bbl Nymex oil prices, current E&P valuations support modest share price appreciation," Gerdes wrote. "Yet, given our expectation for a meaningful pullback in oil/natural gas prices this year relative to the futures market expectation, energy shares should experience a correction in 2006, which would subsequently provide a more compelling buying opportunity."
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