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Short and Long Term Gas Fundamentals Continue to Strengthen




Recent Development


1. · With the spring shoulder season now upon us, the fundamentals supporting increasing gas prices in H2/07 and continued strength over the medium to long term continue to improve [see "Higher Gas Prices Becoming More Certain In H2/07", (April 4, 2007) for further information]. We have previously alluded to what may be a lengthy spring breakup season in a prior note regarding snowpack in western Canada [see "Heavy Snowpack Could Mean Long Spring Breakup" (March 29, 2007)]. This should provide a near-term catalyst for natural gas under potentially lower production levels overall. We are beginning to see signs of that taking place with the 12% rig utilization rate in Western Canada as per the latest report in the Daily Oil Bulletin. Drilling in the month of March was also down 44% from the previous year (down 21% for the quarter YoY) and represents the lowest level since 1999.


2. · Catalysts for longer term price appreciation are emerging as well. The recent U.S. Supreme Court decision confirming the EPA's right to regulate CO2 emissions, and speculation that the Canadian Conservative government will rely heavily on carbon sequestration and low emission coal fire power plants in its green plan, are strong indicators that emissions caps are on the horizon. Under regulation of CO2 emissions, we believe it will be very difficult to obtain permits and construct new coal fired plants to meet increasing electricity demand over the next decade. We use this time frame in recognition that the appropriate sequestration and low emission technology has not yet been fully developed and will also take time to introduce on a wide scale.


3. · Given our view on the prospects for additional coal fired power plants, the most likely alternative to meet increasing demand over the next decade will be further construction of more natural gas fired plants. There are currently 52 coal plants scheduled for construction in the U.S. by 2010. If all these plants are built, we believe that total U.S. natural gas consumption should increase by approximately 5% per year. If none of these 52 coal plants were built and gas fired power plants were constructed instead, we expect that gas consumption would increase by approximately 9% per year. Therefore, with North American gas production set to grow at a maximum of 2% over the next few years, we believe the stage is now being set for stronger gas prices over the longer term as well.




4. · Given our outlook for natural gas, we recommend that investors continue to build positions in quality natural gas-weighted names through the remainder of spring breakup. These include gas producers such as CR and OEX in the E&P sector and FEL.UN in the Royalty Trust sector. TET.UN, PMT.UN, PWI.UN and DAY.UN will also provide the necessary exposure to natural gas. VNG.UN will work as well. It is the most sensitive to natural gas prices among its peers and comes with additional risks/rewards as well (possible merger/acquisition target). We note that WAV.A, CMT and EFE are the E&P gas producers who will be least impacted by a messy and extended spring breakup. We advise investors to be aware that short-term trading opportunities in these names could emerge if the market decides to penalize companies with operations concentrated in areas where breakup is the most severe.




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