U.S. natural gas futures end up, Oct set to expire Wed

NEW YORK (Reuters) - U.S. natural gas futures ended 3 percent higher on Tuesday, underpinned by short covering ahead of the October contract expiration on Wednesday, but high supplies, mild weather forecasts and slowing demand continued to limit the upside.

Many traders said they expect buyers to remain cautious until cooler temperatures arrive to stir more heating load, particularly with storage and production still running at or near record highs.

"We have options expiring today and futures tomorrow, so there has been some book squaring, but I think we need to see a sustained period of cold before we get a significant rally," a Pennsylvania-based trader said.

Front-month October gas futures on the New York Mercantile Exchange, which expire on Wednesday, ended up 8.7 cents, or 3.1 percent, at $2.924 per million British thermal units after trading between $2.843 and $2.943.

Strong buying, focused mainly in the nearby contract, narrowed spreads to winter months after Monday's 10-week high, with the January premium to October slipping 3.3 cents to 61.4 cents. That spread is still up about 34 percent since closing at a 14-month low of 45.8 cents just two weeks ago.

Despite Tuesday's gains, technical traders agree the market seemed trapped in a range between $2.70 and $3, waiting for a reason to break out.

Nuclear plant outages are running 6,200 megawatts above year-ago and may be giving gas demand from electric utilities a boost - gas-fired units usually replace any lost generation - but traders noted the impact was limited by milder temperatures that have slowed overall power loads.

Forecaster MDA EarthSat expects temperatures for the eastern half of the nation to range from normal to above normal for at least the next two weeks. Traders said readings in the high 60s and 70s Fahrenheit were not likely to generate much load.

Coal prices, too, may be a problem for would-be price bulls, with Central Appalachian coal trading at 2-12-year lows at the gas price equivalent of just above $2 per mmBtu.

Concerns persist that some utilities that have been burning cheaper gas to generate power could switch back to coal. Loss of that demand, which helped prop up gas prices all summer, could force more gas into a well-supplied market.

Most analysts agree gas prices need to stay well below $3 this autumn in order to underpin switching demand.

STORAGE SURPLUS SHRINKS, STOCKS STILL AT RECORD

Utilities typically stockpile natural gas from April through October to help meet peak winter heating demand.

Total domestic gas inventories are still at record highs for this time of year and are likely to end the stock building season above last year's all-time high of 3.852 trillion cubic feet.

Record heat this summer helped trim a huge storage surplus relative to last year by 64 percent from its late-March high near 900 bcf.

But traders noted that weekly storage builds were likely to pick up as weather loads fade. Last week's 67 billion cubic feet gain reported by the U.S. Energy Information Administration was the largest weekly injection in more than three months and the third largest so far this year.

(Storage graphic: link.reuters.com/mup44s)

At 82 percent full, total stocks are hovering at levels not normally reached until the second week of October and still offer a huge cushion that can help offset any weather-related spikes in demand or supply disruptions from storms.

Injection estimates for Thursday's EIA report range from 69 bcf to 81 bcf, with most in the mid-70s. Stocks rose an adjusted 104 bcf during the same week last year, while the five-year average increase for that week is 76 bcf.

PRODUCTION STILL AT, NEAR RECORD HIGHS

Drilling for natural gas has been in a nearly steady decline for the last 11 months, with the gas-directed rig count recently posting a 13-year low.

But so far, production shows few, if any, signs of slowing.

(Rig graphic: r.reuters.com/dyb62s )

While dry gas drilling has become largely uneconomical at current prices, gas produced from more profitable shale oil and shale gas liquids wells has kept output stubbornly high.

The EIA expects marketed gas production in 2012 to hit a record for a second straight year, rising 4 percent from 2011 levels to 68.86 bcf per day.

(Additional reporting by Eileen Houlihan; Editing by Sofina Mirza-Reid and Alden Bentley)