Natural gas inventories are filling up at a rapid pace as production continues to grow, and demand remains weak. If this pace of inventory buildup continues, the market may test the theoretical limits of natural gas storage sometime in the fall. (For a primer on the oil industry, refer to our Oil and Gas Industry Primer.)
The Energy Information Administration (EIA) reports storage levels for natural gas every week. The latest report for the week ending June 12 shows that 2.557 Tcf of gas is in storage. This was 622 Bcf higher than the same week last year, and 472 Bcf above the five-year average storage level of 2,085 Bcf.

CNBC reports that, if storage additions just match the five-year average for the next 20 weeks, storage will hit a record of 3.8 Tcf. The EIA estimates storage limits at 3.8 Tcf, but other analysts put the limit higher, as much as 4.2 Tcf.

Several exploration and production companies have attempted to cope with the buildup in natural gas inventories with shut ins of production.

Production Pullback
Earlier in the week, EnCana Corp (NYSE:ECA) shut in production of natural gas in the United States and Canada. Randy Eresman, the CEO of EnCana said that "a couple of hundred million" of production would be curtailed due to low prices. The company produced an average of 3.87 billion cubic feet per day in the first quarter of 2009.

Earlier in the year, Chesapeake Energy (NYSE:CHK) also curbed production of natural gas. The company took 400 million cubic feet per day off the market.

If these two companies were hoping that other large producers would follow, and cut production, it hasn't worked, as no other publicly traded companies have made similar announcements.

There is evidence of producers preparing to cut production without a formal announcement if things get worse, based on internal analysis of the cost to produce. Mark Papa, the CEO of EOG Resources (NYSE:EOG) discussed production shut ins during the first quarter of the 2009 conference call. "We have kind of a threshold well head price that in our minds and I won't give it, but basically, we are not too anxious to sell gas below that price." Papa later added "if storage gets full before November, we'll probably react to it by curtailing some gas."

Other exploration and production companies believe that they lack the scale to influence the market, and leave the large producers to balance the market. Anthony Best, the CEO of St. Mary Land & Exploration (NYSE:SM), said during the company's first quarter of 2009 conference call, "some of the bigger players do it. Because, I think, they honestly believe they can move markets when they do it. We're not big enough to do that. So we're not curtailing. We don't have any intention to do so."

Since companies have different cost structures, each one has a different shut in point. Craig Clark, the CEO of Forest Oil (NYSE:FST) said in early May 2009, "we have nothing shutting this time, because our LOE (lease operating expense) is substantially cheaper than the net-back, if you look at it."

The Bottom Line
Natural gas storage levels are still dangerously high, as the promised fall in natural gas production due to the cutback in drilling fails to materialize. Investors should monitor this development closely as the summer goes on. (Learn about factors that affect oil prices in our article, What Determines Oil Prices?)