NEW YORK -(Dow Jones)- U.S. natural gas supply declined last year and should continue to do so in 2004, but at a slower pace, according to a report by Lehman Brothers.

Analyst Tom Driscoll and his team estimate that U.S. natural gas supply, excluding changes in inventories, fell by about 3% for the full-year 2003 and that it will decline a further 1% in 2004.

The 3% decrease in 2003 supply stems from a 2.8% drop in U.S. production, based on a survey of 53 North American oil and gas producers, and an 11% drop in net imports from Canada for the year. Canadian production declined by 3.2% but growing local demand kept more of the gas at home. Lehman also estimates that LNG imports roughly doubled in 2003 to about 3% of U.S. supply or about 1.4 billion cubic feet per day, and that they will double again by 2008 to about 6% of total U.S. supply.

The outlook for 2004 calls for a much smaller drop in Canadian imports of between 3% and 5%, slowing to a 2% annual decline for each of the years 2005 through 2008. The estimated decline in U.S. production in 2004 is also for a smaller decline of 2% as a near- record number of gas drilling rigs are in production. The decline in the fourth quarter showed no sign yet that this was leading to a rebound as production was estimated to have fallen by 3.1% year-on- year and by 1.5% sequentially over the third quarter.

As U.S. natural gas supplies have peaked and begun to drop in recent years, the resulting higher prices have forced price-sensitive marginal users such as industries that use natural gas as a feedstock to shutter domestic production, helping to keep supply and demand in balance. The market is divided over whether this process of demand destruction can continue to keep prices relatively stable at the new, higher levels.

Driscoll believes that the market is efficient and can adjust fairly quickly to the new supply outlook, much as it did with oil in earlier decades. Others argue that prices will have to find an even higher equilibrium level in the face of falling conventional supply as inelastic consumers such as electric utilities or people heating their homes make up more of the market.