The natural gas-directed rig count has fallen by about 100 rigs from last summer's peak, but further reductions are necessary if the market is to be rebalanced, argue analysts at Barclays Capital in a note published Tuesday. While independent producers appear to have stepped off the gas (in favor of oil), as a group they haven't stopped their pursuit of company-level production growth, Barclays said.

"Producers still care about volumetric growth but need not have it come from natural gas if it can be achieved from higher-value oil," the Barclays team said. "...[A] cut in gas-directed drilling activity need not cause a decrease in gas production. More likely, it would just decrease the rate of growth. We believe that the current level of drilling is adding production to the market."

In order to rebalance inventories by the end of October, the rig count "must be cut sharply," the analysts said. The preference for oil targets has been "a major driver" in lowering the gas-directed rig count. "However, we see limited downside to current drilling levels because of high producer hedging levels, drilling for gas with associated liquids, JVs [joint ventures] and held-by-production leases."

Last August Baker Hughes charted the rig count's peak at 992 while Smith S.T.A.T.S noted the peak at 1,002 in September, according to Barclays. Since then the count has fallen more quickly than the analysts had anticipated to just above 900. "However, after a more-or-less steady drop through the fall and into the beginning of the year, the overall count has stabilized and even gained a few rigs of late," they noted.

Noting that producers charted sequential production growth in 10 of the 12 months of 2010 with an average rig count of 940, the analysts said activity needs to moderate further to a level that puts supply on a declining trend.

"We put this number at approximately 800-850 rigs, though the risk is that even this count could grow supply," they said, "especially as producers work off a backlog of drilled but uncompleted wells in 2011.

"...[W]e calculate that a rig count of 725 from March-October would result in end-of-March inventories of 3.5 Tcf."

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