U.S. natural gas futures surged 14 percent on T hursday, their biggest one-day gain in nearly three years, as a smaller-than-expected build in inventories forced traders to reassess their fears of an unprecedented supply glut later this summer.

After U.S. government data suggested that demand for gas had been much stronger than analysts had anticipated last week, prices blasted through key technical resistance at the 40-day moving average in a day of frenetic trade that recalled the market's wildest days of the past decade.

Front-month gas futures on the New York Mercantile Exchange ended up 31 cents, or 14.2 percent, at $2.495 per million British thermal units after climbing to a two-week high of $2.504. Exchange-wide volume of some 650,000 lots was the heaviest since record highs in January.

The rally was triggered by a relatively small surprise in Energy Information Administration data, which showed domestic gas inventories rose last week by 67 billion cubic feet to 2.944 trillion cubic feet, less than the five-year average for the week. Analysts in a Reuters poll had forecast a 74 bcf draw.

But analysts said the implications of the shortfall in supply were far-reaching, suggesting that many traders were habitually underestimating the number of power plants that were opting to burn gas rather than coal -- a fuel-switching trend that has flummoxed dealers since the beginning of the year.

"The main problem has been getting the demand-side of the equation correct. Electric power is the sector that competes with storage injections," said BNP Paribas analyst Teri Viswanath. "Supply doesn't have the same volatility as demand without major maintenance or storm disruptions."

In nine of the past 10 weeks, domestic gas stocks have increased by less than the seasonal norm, raising expectations that record-high storage can be trimmed to more manageable levels in the 22 weeks left before winter withdrawals begin.

Thursday's modest build was all the more surprising given relatively mild weather so far, which has curbed power demand for air-conditioning. Power output last week was down 10.2 percent from a year ago, according to industry data.

With few signs of broad-based heat on the horizon to stoke demand, some traders remain skeptical of the upside.

"The summer plot isn't written. July and August are expected to be cooler than last year. Consider today an adjustment, not the bears' last hurrah," Gelber & Associates analyst Pax Saunders said in a report.

 

UNCERTAINTY AND VOLATILITY

The supply-demand balance for gas has tightened this year as a slump in prices to 10-year lows prompted some producers to trim output, while some electric utilities opted to use gas instead of pricier coal to generate power.

Lagging data on gas output has also make it difficult to peg just how much producers have cut supply, heightening uncertainty in the market and fuelling a degree of volatility that has been absent for most of the past two years, with prices steady or sliding due to a boom in production of cheap shale gas.

Thursday's rise was the biggest one-day gain for the front month, excluding roll gains from contract expirations, since September 2009, when it notched a 15.1 percent rise.

"We've seen lower production, and on the demand side, we've seen a lot more baseload power generation affecting the storage number," said Eric Bickel, analyst at Summit Energy.

Gas prices have swung wildly this year, sinking to a 10-year low of $1.90 in April after a mild winter left a huge amount of gas in inventory. Then in May, prices shot up to a 3-1/2-month high of $2.76 amid signs of tightening.

Technical traders said Thursday's strong close above the 40-day moving average at $2.361 could trigger more buying.

 

STORAGE STILL AT RECORD

The weekly build trimmed the surplus to last year by 5 bcf to 708 bcf, or 32 percent above the same week in 2011. It also sliced 21 bcf from the excess versus the five-year average, reducing the total to 666 bcf, or 29 percent.

(Storage graphic: http://link.reuters.com/mup44s)

But concerns remain that the storage glut will drive prices lower this summer as storage caverns fill. Inventories stand at 72 percent full, with producing-region stocks at 82 percent of capacity.

The storage surplus to last year will have to be cut by at least another 460 bcf to avoid breaching the government's 4.1-tcf estimate of capacity. Stocks peaked last year in November at a record high of 3.852 tcf.

The EIA said on Tuesday it expected gas storage to climb to a record 4.015 tcf by the end of October, just shy of the government's 4.1 tcf estimate of capacity.

Early injection estimates for next week's EIA report range from 47 bcf to 72 bcf versus last year's adjusted build of 90 bcf and a five-year average increase for that week of 87 bcf.

PRODUCTION GROWTH SLOWING

Traders were waiting for the next Baker Hughes drilling rig report on Friday after last week's data showed the gas-directed rig count fell to 565, its sixth drop in seven weeks and the lowest in nearly 13 years.

A 40-percent drop in dry gas drilling in the last eight months has raised expectations that producers are finally getting serious about slowing record supplies, although many analysts say that total curbs of about 1 bcf per day are not nearly enough to reduce supplies significantly.

On Tuesday, the EIA trimmed its estimates for growth of domestic natural gas production this year to 3.4 percent, while demand will grow by 4.1 percent.