Natural gas supplies are likely to continue growing, according to analysts at UBS Wealth Management Research, since drilling activity has increased by more than 200 rigs since early in the second half of last year.

“We think this increase is likely to keep supply growing,” UBS said in a note Monday. “[T]he U.S. market should be well supplied during 2010. The structural supply and demand mismatch remains an issue and a drag on prices. Falling natural gas imports, especially from Canada, have somewhat dampened the strong domestic supply backdrop but should not alter the overall supply trend.”

Weather-driven recovery in gas demand has not been strong enough to offset the surplus, they said, noting that they expect U.S. gas demand this year to grow only 0.6% over 2009 levels. Industrial demand will be up; however, demand for gas among power generators will be down by about 1.1% from last year, they said.

“Overall, the increase in U.S. demand is unlikely to save prices from falling,” they said. With “solid supply growth,” gas storage should reach “almost full capacity” late this year.

“Thus, we advise investors to avoid natural gas.”

Natural gas is a “buy” when prices are at $4/MMBtu or less, they said. “At these levels we think risk-return is compelling. In the very long run, natural gas prices need to stay at US$5.50 and higher to secure supply.”

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