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The U.S. Energy Department's weekly inventory release showed a larger-than-expected drop in natural gas supplies, as production remained flat and pipeline imports from Canada declined. However, this is largely seen as a one-off shot, with warmer-than-normal temperatures across most of the country restricting the commodity’s requirement for power burn.

In fact, gas stocks – currently 40% above benchmark levels – are at their highest point for this time of the year, reflecting low demand amid robust onshore output.

The Weekly Natural Gas Storage Report – brought out by the Energy Information Administration (EIA) every Thursday since 2002 – includes updates on natural gas market prices, the latest storage level estimates, recent weather data and other market activities or events.

The report provides an overview of the level of reserves and their movements, thereby helping investors understand the demand/supply dynamics of natural gas.

It is an indicator of current gas prices and volatility that affect businesses of natural gas-weighted companies and related support plays like Anadarko Petroleum Corporation (APC - Analyst Report), Chesapeake Energy (CHK - Analyst Report), Encana Corporation (ECA - Analyst Report), Devon Energy Corporation (DVN - Analyst Report), Nabors Industries (NBR - Analyst Report), Patterson-UTI Energy (PTEN - Analyst Report), Helmerich & Payne (HP - Analyst Report) and Halliburton Company (HAL - Analyst Report).

Stockpiles held in underground storage in the lower 48 states fell by 166 billion cubic feet (Bcf) for the week ended February 17, 2012, above the guidance range (of 160–164 Bcf draw) as per the analysts surveyed by Platts, the energy information arm of McGraw-Hill Companies Inc .

The decrease – the thirteenth consecutive withdrawal of the 2011-2012 winter heating season after stocks hit an all-time high in mid-November – is also higher than last year’s draw of 102 Bcf and the 5-year (2007–2011) average drawdown of 145 Bcf for the reported week.

However, notwithstanding the healthy shrinkage during the past week, the current storage level – at 2.595 trillion cubic feet (Tcf) – is up 753 Bcf (40.9%) from last year and 744 Bcf (40.2%) over the five-year average. With this huge natural gas surplus, inventories in underground storage are likely to end the winter close to their highest level of 2.1 Tcf set in 1983.

A supply glut has pressured natural gas prices during the past year or so, as production from dense rock formations (shale) – through novel techniques of horizontal drilling and hydraulic fracturing – remain robust, thereby overwhelming demand.

As a matter of fact, natural gas prices have dropped some 47% from 2011 peak of about $5.00 per million Btu (MMBtu) in June to the current level of around $2.65 (referring to spot prices at the Henry Hub, the benchmark supply point in Louisiana). Incidentally, prices hit a 10-year low of $2.23 in late January.

To make matters worse, mild winter weather across most of the country has curbed natural gas demand for heating, indicating a grossly oversupplied market that continues to pressure commodity prices in the backdrop of sustained strong production.

This has forced several natural gas players to announce drilling/volume curtailments. Exploration and production outfits like Ultra Petroleum Corp. (UPL - Analyst Report), Talisman Energy Inc. (TLM - Analyst Report) and Encana have all reduced their 2012 capital budget to minimize investments in development drilling.

On the other hand, Oklahoma-based Chesapeake – the second-largest U.S. producer of natural gas behind Exxon Mobil Corp. (XOM - Analyst Report) – has opted for production shut-ins to cope with the weak environment for natural gas that is likely to prevail during the year.

However, we feel these planned reductions will not be enough to balance out the massive natural gas supply/demand disparity and therefore we do not expect much upside in gas prices in the near term. In other words, there appears no reason to believe that the supply overhang will subside and natural gas will be out of the dumpster in 2012.

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