Most observers remain bullish on the direction of oil and gas prices in 2005, notwithstanding the record price run-up of 2004. The outlook still hinges on supply, which appears to be flat, and demand, which appears to remain robust. Natural gas scenarios. At press time, the amount of natural gas in storage remained well above the five-year average, almost 15% above, yet gas prices on Nymex were still hovering at $6, with a healthy forward curve extending into the foreseeable future. That led analysts at Simmons & Co. International to conclude that storage inventories may have become less relevant in determining gas prices. Forget short-term weather and storage patterns, they say, and focus instead on the fact that domestic natural gas supply has not really grown during the past five years, and will likely be flat for the next five. In a recent report, they cite a litany of reasons why they are bullish on gas prices. First, they estimate that U.S. gas production fell about 1% last year, after adjusting for the effects of Hurricane Ivan battering the infrastructure in the Gulf of Mexico. They further think U.S. production will decline another 1% this year, and up to 1.5% in 2006. They foresee Canadian imports dropping off 1% annually. Maple Leaf gas flow to the U.S. fell off 8% in 2003 and another 1.2% in the first 10 months of 2004. Further, incremental rig and crew availability may constrain any plans to drill more gas wells in the Lower 48. "We believe that long-term challenges associated with falling domestic production, declining Canadian imports and limited ability to increase liquefied natural gas (LNG) imports will likely continue to support high natural gas prices," the Simmons analysts say. They expect gas prices to trade in a band between $4.50 and $7 per million Btu, even though the number of short-interest holders indicates the consensus view is for lower gas prices in the near term. Calgary-based FirstEnergy Capital Corp. also is bullish. It thinks gas will be around US$6, although it is leaving intact a forecast of $6.25 for 2006 and 2007. The firm also believes daily North American gas demand could grow by 1.6 billion cubic feet this year and another 1.1 billion in 2006. Supply remains a key concern in any scenario. Canadian operators drilled a record number of gas wells last year, close to 26,500 or about 1,600 more wells than were completed in 2003, notes FirstEnergy analyst Martin King. "Despite all this activity, the response in natural gas supplies has been very minimal," he reports. Interestingly, he thinks that notions of large supply losses in the U.S. are changing favorably, with what he calls "more reasonable views" that domestic supply has largely been held flat, with "only minor bumps up or down." Gas prices remain "trapped" in his words, between the price of residual fuel oil and distillates, the two fuels that compete with gas. Oil scenarios. Analysts remain no less upbeat about crude oil prices. The list of potentially disruptive influences that could keep oil prices high is as long as it was throughout 2004. From Venezuela to Russia to Nigeria-not to mention the Middle East-geopolitical and supply challenges abound. In January, FirstEnergy's analysts raised their outlook for West Texas Intermediate crude oil to US$40 from US$38 per barrel and left their 2006 and 2007 forecasts unchanged at $38. They raised their estimate of daily world oil-demand growth in 2005 to 1.8 million barrels from 1.7 million. Jefferies & Co.'s oil-service analysts raised their 2005 oil-price forecast to $41 per barrel and the 2006 outlook to $37. "Certain factors that bolstered prices in 2004 will likely diminish in 2005-06," says analyst Stephen D. Gengaro and his colleagues. "But we believe that weak non-OPEC production growth, limited OPEC excess capacity, a weak U.S. dollar, continued lackluster upstream capital investment and solid demand growth should support crude oil prices over the next few years. "We do not anticipate a sustained decline below the mid-$30s over at least the next two or three years." As more oil companies get comfortable with higher oil-price forecasts for 2005 and beyond, their upstream spending will increase, especially in light of strong cash flows and disappointing internal production growth, in many cases, Gengaro reports. He and his colleagues maintain an Overweight recommendation on oil-service stocks. Factors that could boost world oil demand include the fact that China is trying to fill a strategic petroleum reserve, over and above the demand it is experiencing to fuel its strong economy. According to a new book, China Inc., China is building new infrastructure projects each year-roads, bridges, airports, ports, buildings-that are the equivalent of 10 cities the size of Houston. The country already hosts 100 cities each having a population of at least 1 million people. The U.S. has nine. If anywhere near accurate, this foretells more oil demand. -Leslie Haines

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