Record production and warm winter days are combining to crush natural gas prices, and they could fall further.
Natural gas futures are down nearly six percent already this week, and even if Thursday's weekly inventory data temporarily lifts prices, analysts expect the downtrend to persist. Front-month natural gas futures were down 3 percent Wednesday at $3.11 per million British thermal units.
"The number of rigs producing natural gas is down 53 percent since the peak in 2011. Despite that, we have record production, and we have no weather to speak of," said John Kilduff of Again Capital.
According to Energy Information Administration data, the U.S. was producing a record 73.5 billion cubic feet a day in October in the lower 48 states. (Read More: Track Commodity Price Here)
"One of the factors that helped drive gas prices up toward $4 was the idea that this winter would be cooler than last winter. But now that we've gone through December and the first week of January, we're seeing warm weather. That's why the market pared almost a dollar off its Fall rally," said Tradition Energy analyst Gene McGillian. "In the past year, we've seen a considerable cutback in drilling activity, but the latest production reports from the EIA point to record production levels. We haven't seen our production levels impacted."
McGillian said expectations are that Thursday's EIA inventory report, released at 10:30 a.m. ET, will show a storage withdrawal of between 180 to 200 billion cubic feet. "It would be the largest of the season and repair some of the surplus we've seen," he said.
"We're looking for a high end of 195." That could temporary reverse the decline in prices, he added.
Kilduff said the weather forecasts had been for cooler weather, but as the actual dates approached, the forecasts changed.
"We're going to experience weather here in the next several days close to 60 degrees. The weather forecast for the second half of January was for below normal, but that's moderating. As you get closer to the date, the jet stream just doesn't move, and you get this more moderate pattern," he said, from his office in New York. The National Climatic Data Center reported this month that 2012 was the hottest year on record, warmer by a full degree.
Temperatures Wednesday were in the upper 40 degrees Farenheit in the mid-Atlantic states and above freezing in much of New England. The Midwest saw day time temperatures in the 40s and up to the mid-50s.
"It's pretty clear if we come in next week, and it's an above average forecast, we're going to flirt with that $3 level," McGillian said.
Kilduff agrees. He said the market is finding support at current levels, between $3.10 and $3.12 per million BTUs. "It could easily fall back down to $3.06 pretty quickly. The 200-day moving average is around $2.91," Kilduff said.
McGillian said the market is betting gas prices will stay low for a long period. The futures market is trading below $3.40 for the balance of the year and the 2014 contracts are all below $4 per million BTUs, he said.
The U.S. has benefited from shale gas technology and unconventional drilling that has given it what is expected to be a 100 year supply of natural gas. The abundance of gas has also made it likely some of it will be headed to the export market, but McGillian said it will take at least until 2015 before any significant facilities are operating. He said once gas is exported, that could put upward pressure on prices. (Read More: US Pumps Up Oil Output to Highest Level in 20 Years)
The EIA, in its short-term outlook Tuesday, said natural gas working inventories ended the year at 3.5 trillion cubic feet, just above the year earlier level. EIA also said it expects the Henry Hub natural gas spot price, which averaged $4 in 2011 and $2.75 per million BTU in 2012, to average $3.74 in 2013 and $3.90 in 2014.