The Fed has declared the recession all but over and it appears the stock market agrees. Domestic natural gas prices may rise as production continues to slip from year-ago levels, and winter is around the corner. Drilling activity has rallied through the early fall, with the U.S. rig count inching back up past the 1,000 mark, mostly due to higher crude oil prices.

Many people are thinking 2010 looks pretty good—the oil picture is getting brighter, the economy may finally be on the mend, and Republicans are likely to make gains in the mid-term Congressional elections.

There should be smiles all around.

But for many independents, one nagging issue remains: the direction of natural gas prices. Onshore U.S. production rose 0.6 billion cubic feet a day in June over June 2008 levels, although the long-term trend is otherwise: onshore output declined four months in a row since February, according to government data. Increased offshore production, thanks to no hurricane effects this year, is skewing the outlook. So, watch carefully for data released at the end of October, which will reveal preliminary production numbers for August.

Meanwhile, at press time, the Organization of Petroleum Exporting Countries and the International Energy Agency each hiked their global oil-demand forecasts for 2010. OPEC, commanding about 40% of world oil supply, says oil demand will slip only 1.8% this year, by 140,000 barrels per day, to average 84.05 million a day. But for 2010, it is estimating demand will go up 0.6%, or by another 150,000 barrels per day, to 84.56 million a day.

In September, OPEC said oil prices of around $70 a barrel “are likely to persist.” Still, prices have risen 53% year-to-date, and in the face of a severe worldwide recession, no less.

The IEA, meanwhile, raised its 2010 consumption outlook three times as much as OPEC did, in a report released September 10. The agency upped its 2010 forecast by 450,000 barrels a day to an average 85.7 million a day.

Going long, the analysts at Morgan Stanley recently predicted oil could reach $105 per barrel by 2012, at which time the firm thinks global demand may have recovered enough to create a tight supply again, just as we saw in 2007 and early 2008. This outlook is based on the firm’s proprietary database of 460 new oil fields coming online around the world in the next few years. It is countered by decline curves elsewhere, and clouded by the fog of geopolitical uncertainty and/or declining production in the usual problem nations: Nigeria, Venezuela, Mexico, Iran and Iraq.

For U.S. producers of natural gas, the crystal ball seems cloudy. Storage inventories at press time were nearly half a trillion cubic feet (503 billion cubic feet) above the five-year average. Morgan Stanley’s Stephen I. Richardson warned the natural gas market “faces full storage, production shut-ins, and the prospect of continued weak prices through November. The market saw additional OFOs (operational flow orders) from pipeline operators limiting flows and impacting regional cash pricing.

“We expect continued tough trading for the equities as visibility on the timing of the 2010 recovery is obscured by extreme near-term dislocations and the prospect of a rising rig count (Baker Hughes Inc.’s gas-directed rig count…is now 36 above the lows),” Richardson said.

The E&P research team at Tudor, Pickering, Holt & Co. Securities spent six months building a new natural gas model that is a “bottoms-up, basin-specific, type-curve driven, history-matched model, using data from nearly every producing well in the U.S.” Their conclusions are summarized elsewhere in this issue, but the bottom line is this: A precipitous drop in drilling activity from the peak in third-quarter 2008 leads to year-end 2009 wellhead supply declining 5 Bcf a day or 8%, vs. year-end 2008. And by second-half 2010, gas supply could be down 6.5 Bcf a day or 10% from year-end 2008. A gas-price rally would follow, assuming some kind of demand recovery next year.

All of these predictions are tempered by what Congress may do vis-a-vis the Waxman-Markey energy bill. In Houston recently, there was a rally of another kind, as some 3,500 people, mostly from the oil and gas industry, rallied to complain about adverse government proposals that they say would kill energy jobs and drive up the price of gasoline. As I approached the venue, I was told that the valet parking area was full. I looked around to see that it was full of gas-guzzling SUVs. Not a Prius in sight.