U.S. natgas 50-percent price rally likely to lose steam

NEW YORK (Reuters) - U.S. natural gas prices, having bounced more than 50 percent since hitting a 7-1/2-year low earlier this month, may not have much higher to go in the near term as brimming inventories and weak demand leave the market oversupplied.

After sliding to $2.409 per million British thermal units in early September, the lowest level for a nearby natural gas contract on the New York Mercantile Exchange since March 2002, prices rebounded this week to the $3.70s.

"This is less a rally than a price recovery. The market was oversold below $3, and there's been a bunch of short covering, but gas is piling up in storage, and the recent lift in prices ignored that," said Pax Saunders, analyst at Gelber & Associates in Houston.

Natural gas traders, noting funds were carrying huge short positions, said news last week that the United States Natural Gas Fund (UNG.P), a long-only ETF, would issue new shares later this month and concerns that CME Group (CME.O) would tighten enforcement of NYMEX position limits, helped trigger the rush to cover, or buy back shorts, to lower total exposure.

Also, gas prices often rally in late summer or early autumn as traders anticipate stronger winter demand.

But some analysts expect this year to be different, with inventories at record highs, summer temperatures fading and a sluggish economy slowing gas use, particularly from industry which accounts for nearly 30 percent of total consumption.

"I don't think the market has any significant legs to the upside. We've very likely seen the bottom, but there's an awful lot of overhang in supply that should keep prices in check," said Chris Kostas, gas analyst at Energy Security Analysis Inc.

Analysts agree a lot depends on winter, a time when demand for gas to heat homes and businesses is at its peak.

SUPPLY GLUT

Domestic natural gas inventories will be heading into winter at all-time highs, and unless the heating season turns out cold, storage is likely to still be high this spring, which could limit expected price gains next year.

U.S. Energy Information Administration data showed total gas inventories climbed to 3.458 trillion cubic feet last week, and at current build rates, are probably just two weeks away from breaking the record of 3.565 tcf hit in 2007.

With seven weeks left in the stock building season, analysts expect storage to hit new highs above 3.8 tcf by November.

Inventories are a key source of supply that help utilities meet peak heating demand, and the huge cushion means there will be no supply shortfalls this winter.

The 75 percent slide in gas prices, since peaking last summer above $13, prompted steep cuts in drilling and helped slow production as few producers, if any, can make money at prices under $3. But most analysts agree the shut-ins so far have only modestly tightened the supply-demand balance.

"Production declines have not happened as quickly as we expected," ESAI's Kostas said.

While output is expected to decline further this and next year, analysts say even steeper cuts in demand, particularly from the industrial sector due to the recession, will make it difficult to balance the market until the economy recovers.

HIGHER PRICES NEXT YEAR

Despite the current supply glut, most analysts expect gas prices to improve later this year and next year.

Forward gas prices through 2010 are still hovering well above $5.50, reflecting first the expected increase in demand this winter, then further declines in production and some improvement in industrial use as the economy recovers in 2010.

But even with a tighter supply-demand balance next year, analysts generally agree huge reserves of gas should temper price gains.

"There is a flexibility of supply which means that prices next year will not go to the moon," said Jason Schenker at Prestige Economics, a Texas-based energy consultancy.

Analysts note some very prolific shale basins are located close to existing drilling and pipeline infrastructure and can easily be tapped if prices move back to the $4.50 or $5 level.

In addition, LNG, or liquefied natural gas, will again be a big wild card next year, with new production projects having the potential to flood the global market and drive more supply to U.S. shores.

"There's a lot of new LNG supply expected next year, which should help reduce any run up in prices," ESAI's Kostas said.

(Reporting by Joe Silha; Editing by Marguerita Choy)