| NEW YORK
NEW YORK Natural gas futures finished sharply lower on Tuesday as forecasts for moderate U.S. weather and an ever growing supply glut sparked selling that knocked the front-month contract to a new 10-year low.
Tuesday's slide followed a nearly 2 percent rally on Monday when the market staged a technical bounce after falling 5 percent last week.
With storage at a record high for this time of year and production still running at or near an all-time peak, most traders remain skeptical of any upside in prices at least until some sustained heat forces homeowners and businesses to crank up their air conditioners and boost demand.
"We're in the (spring) shoulder period, and storage is already jam packed. We've got a big oversupply right now," a New England-based trader said, noting weather demand was fading.
Front-month gas futures on the New York Mercantile Exchange ended down 6.5 cents, or 3.2 percent, at $1.951 per million British thermal units after sinking late to $1.947, the lowest for a nearby contract since January 2002.
AccuWeather.com expects average temperatures be above normal in the Northeast for the next week, while the Midwest, another key gas consuming region, should have mostly below-normal readings then.
Extended forecasts do show some heat in the West, but normal or below-normal temperatures for the eastern half of the country are not expected to stir much heating or cooling demand.
STORAGE, THE BIG WEIGHT ON PRICES
Utilities typically build inventories from April through October to help meet peak winter heating needs.
U.S. Energy Information Administration data last week showed that total gas in storage rose by 8 billion cubic feet to 2.487 trillion cubic feet.
While the build was well below market expectations and seen as slightly supportive, it drove stocks further into record territory for this time and left a huge surplus that could turn out to be the biggest pressure on prices this year.
Inventories still stand at more than 900 bcf, or 59 percent, above the five-year average, a huge cushion that could help meet any spikes in demand or storm-related disruptions in supply.
(Storage graphic: link.reuters.com/mup44s)
Injection estimates for Thursday's EIA report range from 19 bcf to 41 bcf, with most in the mid-20s. Stocks rose an adjusted 42 bcf during the same week last year, while the five-year average increase for that week is 26 bcf.
If weekly stock builds through October match the five-year average pace, inventories would top out at 4.595 tcf, a physical impossibility if peak capacity estimates of 4.1 tcf are correct.
That could tank prices later in the injection season if storage caverns fill up and force more gas into an oversupplied market.
PRODUCTION, ALSO NEAR RECORD HIGHS
The nearly steady drop in dry gas drilling -- the Baker Hughes gas-directed count is down a third since peaking at 936 in October -- has stirred expectations that low prices were finally forcing producers to slow record gas output.
(Graphic on rigs vs prices: r.reuters.com/dyb62s)
But an EIA report last week offered little hope for bulls. The agency again raised its estimate for marketed gas production this year, expecting output in 2012 to climb by 3 bcf per day, or 4.5 percent, to a record 69.22 bcf daily.
Analysts say any slowdown in dry gas production could take a lot more time, noting increased drilling for shale oil and shale liquids still produces plenty of associated gas that ends up in the market after processing.
SIGNS OF TIGHTENING
Despite the oversupply, there are some signs that the market has tightened this year.
Coal-to-gas switching offers the best chance of burning up some of the excess supply.
Low gas prices have prompted utilities to switch from coal to cheaper gas to generate power, adding as much as 5 bcf per day, or 7 percent, to total U.S. gas demand this year.
Some analysts say there could be another 2 bcfd of potential switching if gas prices fall a bit more.
A Bentek Energy report on Tuesday said gas demand from power generators in the Southeast is averaging 7.3 bcf per day, or 35 percent, higher than year-to-date 2011 levels.
Cheap gas prices have also drawn more interest from energy intensive industries like petrochemicals, steel and paper. Demand from the industrial sector is estimated to be up about 0.5 bcf per day this year.
(Reporting By Joe Silha; Editing by Bob Burgdorfer)