U.S. natural gas: so much they'll be giving it away

NEW YORK (Reuters) - The unrelenting surge in shale gas production and one of the warmest winters on record are driving the natural gas market toward uncharted territory. Soon companies may have to pay to get rid of their gas.

As benchmark gas futures plummet to their lowest level in nearly a decade, analysts are considering the prospect that prices could actually turn negative as utilities and traders scramble to sell off surplus gas supplies held in storage caverns to avoid hefty contractual fines.

While the exceptionally mild weather is largely to blame for U.S. gas inventories being more than 20 percent above the norm, the deep slump in prices also underscores how the fracking-induced drilling boom that has turned the U.S. energy industry on its head continues to roil the market.

Unlike 2009, gas drillers this year may be more reluctant to shut down wells and idle rigs in a bid to support prices, since firms like Chesapeake Energy (CHK.N) can still make profits by producing crude oil or other liquids from the same wells. With gas cheaper than coal in many places, utilities are already burning as much of the stuff as they can.

As a result, some say, prices now seem to be bottomless.

"In the short term there is really no price floor for natural gas," said Shiyang Wang, commodities analyst at Barclays Capital in New York.

The seven-day collapse in prices accelerated on Thursday, with front-month Henry Hub futures diving to $2.30 per million British thermal units (mmBtu), the lowest since February 2002, marking the steepest sell-off in five years. Prices touched a low of just above $1 per mmBtu back in 1992.

The dramatic price collapse feeds into an emerging industrial tussle between producers -- who want to export gas to capture global prices that are up to five times higher -- and big consumers like Alcoa (AA.N) who want cheap domestic energy.

The U.S. Energy Department waded into the debate on Thursday, saying that gas prices could be 9 percent a year more costly over the next two decades if all the export terminals now being proposed were built.

But even the first of those is at least three years away, and the shale drilling boom is set to keep pressure on prices for years if not decades, putting the near-term focus solely on the weather.

If the mild winter continues, storage capacity could overflow come autumn, forcing companies in extreme cases to sell gas at next to nothing or even pay a customer to take it off their hands. On Tuesday the National Weather Service said the warm conditions should continue into next month.

"We needed a brutally cold winter to clear out inventory. We have had the complete opposite," said Chris Jarvis, president at Caprock Risk Management in Rye, New Hampshire. He expects natural gas to fall to $2 in the coming weeks if the weather remains warmer than normal.

<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Graph on inventories link.reuters.com/mup44s Graphic on rigs r.reuters.com/dyb62s

^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

INVENTORIES ABRIM

Winter normally provides a boost for natural gas prices as households and businesses step up consumption for heating. Inventories that build up over the summer months are steadily drained until April, when the cycle begins anew.

But the winter this year has so far been the fourth warmest on record, according to forecaster MDA EarthSat, adding to the pressure already provided by record production.

With few signs that producers are shutting in output, the market's focus is squarely on the storage operators, who have to run a carefully calibrated system in order to ensure that their tanks and caverns are empty enough in April to accommodate all the excess supply that will build up over the summer.

Utilities are contractually obliged to inject and draw agreed amounts of gas from storage each month. Faced with hefty fines for holding too much gas in storage -- up to $10 per mmBtu -- companies can be forced into emergency sales.

"It has happened for very brief periods, a couple of days at most, during an extreme case like a force majeure," an East Coast gas marketer said, referring to sellers dumping gas at prices well below market levels.

Even if inventories eventually fall far enough by the end of winter, traders would still likely face a nervy summer injection season that could fill storage to the brim -- creating the same problem all over again.

U.S. natural gas inventories are at record highs for this time of year, nearly 20 percent above the same week last year.

SOMETHING BULLISH?

If the weather stays warm, two key factors could yet bolster prices: producers cutting production, and utilities moving away from coal to use cheaper gas for power generation.

For two years, producers like Chesapeake and Exxon Mobil (XOM.N) have fretted over the thin margins created by low gas prices. But while the rig count has fallen this year, gas production remains at record highs.

"I do not see producers cutting much, if anything, in the short to medium term," said Dominick Chirichella, senior partner, Energy Management Institute in New York.

Even if rigs do decrease further, production is unlikely to be affected for at least six months due to the army of drilled wells that is set to come online, as well as the large volumes of associated gas produced in the current U.S. oil-producing boom.

And while utilities have switched off some coal plants in favor of gas-fuelled facilities that will consume an additional 5 billion cubic feet per day this year, about a third more than they were running a year ago, it hasn't been enough.

So for now, Americans get a two-fer: a respite from the bitter winters of recent years and cheap gas to boot.

"Mother Nature has become a huge bear," said Kyle Cooper, managing IAF Advisors, Houston.

(Additional reporting by Joseph Silha in New York; Editing by Bob Burgdorfer)