Independent producers suffered a hit to their earnings in 2002 from 2001 as they realized lower natural gas prices in the first half of the year. But analysts overwhelmingly predict tight gas markets this year, and some independents are bumping up their drilling plans to benefit. Independent producers tracked by Petroleum Finance Week reported a 35.5% decrease in year-over-year earnings and a 9.6% decrease in revenues. Their average daily gas production was 7.2% higher in 2002 than in 2001, but their realized prices were 27.9% lower. Oil and condensate production was up 4.1%, and realized prices were up 1.8%. "Despite disappointing natural gas prices in the first half of 2002, we elected to continue our drilling momentum because of our belief in the tight North American gas-supply fundamentals," says EOG Resources Inc. chairman and chief executive officer Mark Papa. It seems as if everyone else in the industry shares that belief. A new study by ICF Consulting says the current tight gas market will continue through 2005. The Fairfax, Virginia-based firm thinks the Henry Hub spot price will average more than $4 per million Btu through 2004 and at least $3.50 over the longer term. One of the biggest gas bulls, Raymond James & Associates, now says that $6 per thousand cubic feet is its new forecast for 2003, up from $5. This is higher than the Wall Street consensus of $4.40 and the mid-March Nymex futures strip of $5.59. FirstEnergy Capital Corp. recently declared: "Building U.S. gas storage back to adequate levels [3 trillion cubic feet] by the start of November may present the most formidable task industry has ever faced." The Calgary-based research firm notes that the deficit in U.S. storage to the five-year average is approaching a record. Even minimal withdrawals of gas from storage through the end of March suggest the storage season will end with about 725 Bcf in storage-a record low. "The odds are growing that a price spike this summer will occur should storage be shaping up to be poor," the FirstEnergy report concludes. Hoping to take advantage of high gas prices is Pioneer Natural Resources Co. In 2002, the company focused spending on large project facilities such as the Canyon Express project in the Gulf of Mexico. But it plans to spend a higher percentage of its 2003 capital budget on drilling. It expects to drill about 450 wells this year, up from 229 in 2002. Given the high commodity price environment expected for the year, this doubling of activity is a good thing, says Bob Christensen of First Albany Corp., who upgraded Pioneer to Strong Buy from Buy, and selected the company as his best pick for the first half of 2003. "The company, in our view, offers one of the highest, if not the highest, production-volume growth stories in the big-cap E&P sector over the next 24 months-45% and 18% in 2003 and 2004, respectively." Another independent emphasizing drilling is Pogo Producing Co., which plans its most aggressive drilling schedule to date this year with 226 wells. In 2002, it drilled 172 wells. However, with increased activity, costs are expected to rise as well. Lloyd Byrne of Morgan Stanley commented on this trend in a report on Anadarko Petroleum Corp. While Anadarko's core production is expected to be up 5% per share this year and 10% in 2004, Byrne said its lease operating expense and depreciation, depletion and amortization expenses are expected to rise, too. "In fact, based on preliminary Anadarko guidance for 2003, LOE and DD&A are projected to increase [up to ] 10% each year-over-year," he said. "Increased drilling/workover activity is behind the LOE increase, while a larger depletable cost base is pressuring DD&A. This trend is not specific to Anadarko, but rather is something we're seeing across the entire space." The Houston Exploration Co. increased its depletion and depreciation expense estimate for 2003 to $1.80 per thousand cubic feet of gas equivalent. The rise is due to higher estimated future development costs for its proved undeveloped reserves and the transfer of capitalized costs relating to unevaluated properties to the amortization base, the company reports. Separately, Nuevo Energy Co. reported that its DD&A costs rose 5% in 2002 from 2001 due to increased production and a higher DD&A rate. When it comes to finding costs, Anadarko's 2002 numbers were higher than it may have liked-$10.52 per barrel of oil equivalent (BOE) for proved reserves. Some $2 of that was attributable to two factors: revision of Venezuelan reserves and large investments in leases in the eastern Gulf of Mexico, which have not yet been drilled, the company reported. Without those factors, finding costs would have been around $8.75. The company expects to be in the $7 range for 2003. "With stronger commodity prices, and still reasonable drilling and service costs, we're ready to start growing production again, and we're well positioned to do that in 2003 and 2004," the company reported. Another issue that plagued independents in 2002-transportation of Rockies gas to more markets-should find some relief this year, with the expansion of the Kern River pipeline, says Brad Beago, an analyst with Credit Lyonnais Securities. Devon Energy Corp.'s U.S. gas basis differentials were wider than expected due to Rockies transportation. -Jodi Wetuski