UPDATE 3-High supplies, weather drive US natural gas futures lower

Tue Feb 21, 2012 3:34pm EST

* Moderate U.S. weather forecasts pressure prices

* Record-high production, storage also weigh on market

* Recent gas rig count declines lend some support

By Joe Silha

NEW YORK, Feb 21 (Reuters) - Front-month U.S. natural gas futures ended lower on Tuesday as mild U.S. weather this week and record-high supplies weighed on prices despite the recent decline in drilling that could finally slow record production.

Planned output cuts by several key producers and recent declines in the gas drilling rig count to a 28-month low helped drive gas prices up 8 percent last week.

But with production still running at or near all-time highs and inventories likely to end winter at a record high, most traders remained skeptical of any upside without much-colder late-winter weather to kick up heating demand.

The front-month gas futures contract on the New York Mercantile Exchange finished down 5.8 cents, or 2.2 percent, at $2.626 per million British thermal units after trading between $2.575 and $2.673.

"On the weather front, the six- to 10 day and eight- to 14 day forecasts are still showing above-normal temperatures for the eastern one-third of the U.S. I do not expect the overhang of natgas inventories to dissipate anytime soon," Energy Management Institute's Dominick Chirichella said in a report.

"On the producing side, some production has been shut in both in the U.S. and Canada ... but it is not nearly enough to have a material impact on the overall supply and demand balances," he said.

AccuWeather.com expects temperatures in the Northeast and Midwest, key gas-consuming regions, to mostly average above normal for the next five days, then cool to seasonal or slightly below seasonal later this week and early next week.

But in its 11- to 15 day outlook, private forecaster MDA EarthSat sees above-normal temperatures dominating the eastern half of the nation, with seasonal or below-seasonal readings only expected in the West.

SUPPLY GLUT PERSISTS

Baker Hughes data on Friday showed the gas-directed rig count fell last week by four to 716, its lowest since October 2009. It was the sixth straight weekly decline and stirred more talk that low prices were finally forcing drillers to slow dry gas operations.

(Drilling rig graphic:)

On Friday, Encana said it would shut in 250 million cubic feet per day of North American gas production immediately and expects to reduce output by up to 600 mmcf per day by the end of the year.

But many traders remain skeptical of announced production cuts, noting the planned reductions so far were not enough to tighten a market oversupplied by as much as 3 billion cubic feet per day, or more than 4 percent.

Analysts said the recent slowdown in drilling has yet to be reflected in pipeline flows. They noted that producers have shifted spending to higher-value oil and gas liquids plays which still produce plenty of associated gas that ends up in the market after processing.

Most analysts, noting it will be difficult to balance the gas market without serious production cuts, do not expect any major slowdown in gas output until late this year.

STORAGE, A BIG PROBLEM FOR PRICES

Despite last week's price gains, one of the mildest winters on record has slowed storage draws by about 530 billion cubic feet, or 33 percent, and left a huge cushion in inventories that could cap any price gains this year.

Last winter at this time, cold weather had forced storage owners to pull more than 1.9 trillion cubic feet from inventory to help meet the surge in heating demand, but this season, only about 1.1 tcf of storage gas has been burned up, a 42 percent drop.

Data from the U.S. Energy Information Administration last week showed total domestic gas inventories stood at 2.761 tcf, still a record high for this time of year.

(Storage graphic:)

Stocks are now 817 bcf, or 42 percent, above last year and 765 bcf, or 38 percent above average, a huge cushion that can easily meet any late-winter spikes in heating demand.

With extended forecasts still not showing any extreme cold on the horizon and winter winding down, traders said the huge surplus could pressure prices in late March if contractual obligations force utilities to cycle gas out of inventory to meet seasonal turnover requirements.

Gas prices hit a 10-year low of $2.231 in late January.

Early withdrawal estimates for next week's EIA report range from 110 bcf to 171 bcf versus last year's drop of 102 bcf and the five-year average decline for that week of 145 bcf.

A Reuters end-winter inventory poll last week showed analysts expected stocks to end the heating season at an all-time high of 2.215 tcf, 43 percent above average and well above the previous record of 2.148 tcf set in 1983.

The inventory glut could also spell trouble for prices late in the summer stock-building season if inventory owners run out of room to store gas, forcing more supply into the market.

Estimates for U.S. working gas storage capacity range from 4.1 tcf to 4.4 tcf, a level that could be tested if storage builds from April through October match last year's 2.2 tcf.

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