There’s no shortage of bearish sentiment in the market today about potential weakness in gas pricing in the second half of the 2007-08 winter.

Why? Third-quarter 2007 U.S. gas production was up 2% versus the like 2006 period, according to a recent Raymond James & Associates survey. This analysis was supported by a late fall International Energy Agency report showing a 2.8%, or 1.6-billion-cubic-foot (Bcf), increase in daily domestic gas output for August 2007 versus the same prior-year month.

“Even though U.S. gas producers are facing an accelerating and steepening treadmill of decline rates, it’s clear that something has changed in the past year that is now allowing domestic gas production to buck a decade-long, declining gas-well-productivity trend,” says Raymond James analyst John Freeman in Houston.

He opines that the high initial production rates of the Barnett shale and other less prolific shale plays are responsible for this shift.

Increased gas supply, coupled with an outlook for normal winter weather, leads Freeman to forecast storage withdrawal of up to 30% less gas—more than 300 Bcf—during the final 10 weeks of the 2007-08 winter season than a year ago.

“If our projections are correct, the market will be left with a bloated 1.7 trillion cubic feet of winter-ending storage,” he says. “Such high storage levels will likely [cause] downward pressure on natural gas prices through the spring of 2008.”

What’s more, increased U.S. gas supply this summer and a hefty increase in liquefied natural gas (LNG) imports should further saturate the gas market, the analyst says. “Therefore, we have significantly lowered our full-year 2008 (gas-price) forecast from $10 per thousand cubic feet to $7.”

This bearish outlook aside, Shannon Nome, E&P analyst for Deutsche Bank Securities Inc. in Houston, believes gas fundamentals are being masked by mild weather and some unsustainable contributions on the supply side.

She points out that, in early 2007, the gas rig count was up 15% year-over-year. “Today, however, it’s flattish, and we think this will show up in a slowing rate of production growth.” Nome also notes that U.S. gas prices are now too low to attract much, if any, incremental LNG from the spot market.

“More importantly, we don’t think (upstream) stocks are pricing in any major commodity-price upside potential from here,” she says. “While year-end reserve reports may suggest that finding and development costs remain on the rise, given basin maturity and shrinking prospect sizes, this (only) underscores the difficulty of adding new supply and should continue to underpin not only commodity prices but E&P asset values.”

The sanguine Nome believes 2008 will be a good year for gas-weighted E&P stocks, and that investors should be capitalizing on dips in upstream equity values in order to establish positions in advance of the teeth of this winter season.

Her top large-cap pick is Chesapeake Energy Corp. (NYSE: CHK), for which she has a 12-month target price of $55.

“We feel 2008 has the potential to be Chesapeake’s breakout year,” she says. “The company’s fundamental performance has been rock solid, as production and costs have consistently beaten expectations. And while the stock has been held back by concerns that it will continue to bridge its funding gap with equity, several planned asset monetizations and a recent $1-billion capex cut should put Chesapeake in a cash-flow-positive position through year-end 2009.”

She adds, “As the company delivers on promises to convert its massive domestic acreage inventory into production and cash flow, investors should reap the rewards.”

Among midcap E&P companies, the analyst’s favorite for 2008 is Range Resources Corp. (NYSE: RRC), with a 12-month target price of $51. “We like Range’s long reserve life, extensive gas-weighted drilling inventory, lean cost structure, low-risk and conservatively booked reserves, and its tendency to reliably deliver on volume-growth targets.”

Within the small-cap E&P set, her favorite for 2008 is Delta Petroleum Corp. (Nasdaq: DPTR), with a $27 target price. “It remains a top near-term pick based on its cheap valuation, solid 40% to 60% production-growth visibility for 2008, and the free optionality represented by its exploration program.”

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