Demand weakness has forced domestic natural gas producers to lay down rigs at a quick clip, but inventories still may finish the 2009 injection season with 3.9 Tcf in storage, Barclays Capital energy analysts said in a report this week.

However, this “comfortable” inventory “will likely be masking deep production declines” by the second half of this year, and without a drilling recovery, the market may have historically low inventories by the second half of 2010, said analysts James Crandall, Biliana Pehlivanova and Michael Zenker in their latest “Natural Gas Weekly Kaleidoscope.”

With gas demand lower than it was six months ago, supply has been forced to play catch-up, and now “both are shifting at an unprecedented pace in a veritable race to the bottom,” said the trio. “Overshadowed by the looming uncertainties in demand, supportive supply-side developments are taking place unnoticed, at least as far as prices have been concerned.”

For U.S. gas producers, the past few months have sent a “strong signal: stop drilling as soon as you can,” said Crandall and his team. The rig count decline has accelerated since the beginning of the year, “leading to a pullback unprecedented in depth and pace. Given our expectations for continued price weakness through the rest of 2009, the duration of the drilling downturn is likely to be unprecedented as well.”

Under current rig count levels, the Barclays analysts said sequential declines, if not already under way, should occur in the “very near future.” Assuming the rig count finishes 2009 at 700, which would require another 150 or so rigs to fall, “domestic production could be down as much as 3.8 Bcf/d year/year (y/y) by December 2009…”

Also on the horizon are more liquefied natural gas (LNG) imports, said the analysts. LNG deliveries to Asia, they noted, are already falling and global LNG markets “are heading for oversupply.” Given the uncertainty in global gas markets, the possible outcomes for U.S. imports is “unusually wide,” but U.S. imports in 2009 are forecast to be 2.1 Bcf/d, more than double the average 1 Bcf/d expected in 2Q2009.

“Inventories are on track to remain in overhang” through early 2010, the analysts said.

“If prices do not rebound and drilling efforts remain depressed, the U.S. market could be heading toward historically low inventory levels” by the second half of 2010,” said the trio. “Thus, we believe the back end of the natural gas forward curve, particularly calendar year 2011, will have to rebound above $7 [per Mcf] to encourage drilling and stem accelerating production declines. The implication should be a steepening contango of the forward curve.”

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