XTO Xto Energy, Inc.

By Steve Gelsi

NEW YORK (Dow Jones) -- Sector leaders in the U.S. natural-gas-production business are wrapping up their bleakest winter in years, and prospects are clouded by oversupply, icy credit markets and a global recession.

The mightiest players -- Devon Energy (DVN), Apache (APA), XTO Resources (XTO) and EOG Resources (EOG) -- have seen their stock prices plummet as their fortunes fall sharply alongside plunging commodity prices.

While more than a month of the cold season remains on the calendar, the most lucrative period of increased residential and business heating demand has mostly ended for natural-gas producers, with historically high stockpiles on hand.

This past week, U.S. natural-gas supplies stood at 2,020 billion cubic feet, or 44 billion cubic feet more than last year at this time and 24 billion cubic feet above the five-year average.

Meanwhile, natural-gas prices have fallen to well below $5 per thousand cubic feet from well over $10 during the energy-bubble days.

"You had too much supply, and now you have contraction in demand. ... It's a bit of a double whammy," energy analyst Mark Leggett of BMO Capital Markets said, explaining the headwinds faced by natural-gas producers.

While winter temperatures have been lower than typical in much of the country for stretches this winter, the economic slowdown, coupled with a buildup in natural-gas production infrastructure during the energy boom, has led to oversupply even during periods of increased need for heat.

To cope with chilly prospects, companies are drastically slashing their capital budgets for the coming year and shoring up their balance sheets as cash reigns.

"We've seen some extreme volatility where it looked like a brief recovery, but now it's back to the cash-flow-neutral budget and a focus on the balance sheet because of the soft gas-price environment," Leggett said.

While many natural-gas producers were heroes on Wall Street during the energy boom of 2007-08 because of their advances in tapping into domestic natural-gas supplies and easing the need to import the fuel, times have quickly changed.

Harold M. Korell, CEO of Southwestern Energy Co. (SWN), said the industry faces its toughest conditions in at least six years.

"For the most part, what you see happening when you see the cutbacks [is that] people are not drilling as many wells, and so the overall production volume of the country will gradually decline -- it's like letting air out of a tire," Korell said.

"Companies have to cut back if they find the economics on their projects won't be supported by current natural-gas prices, and that's the case in many situations today. In addition to that, if they also happen to have a lot of borrowing then they find it to be an extremely difficult time. It's painful for a lot of companies in the current environment."

Korell said Southwest Energy's early position of 860,000 acres in the gas-rich Fayetteville shale region in Arkansas allows it to produce natural gas economically even at today's depressed prices.

Southwestern isn't reducing its 2009 capital spending, although it did trim it from its projections earlier last year. The company, which is a component of the S&P 500, plans to spend $2 billion on capital projects in 2009, up from about $1.5 billion in 2008.

"If anyone believes gas prices are going back up anywhere from six to eight [months] or a year from now, we're going to be so well-positioned because all that production is going to hit the market at those higher prices," Korell said. "I suspect that'll happen."

Jim Byrne, an analyst at BMO Capital Markets, said home and business owners are benefiting from cheaper natural gas, even as producers struggle.

"This year heating-oil prices [and] natural-gas prices are down significantly so utility bills for the average consumer will be down sharply," he said. "The weather has been cold, certainly to offset some of that, but relative pricing is definitely down. Next winter it's still be a little too early to determine, but chances are you're not going to see a huge run-up between now and then, so the next couple of years the consumer may get a little break on the utility side."

While short-term prospects for natural-gas producers remain in question, BMO Capital Markets has maintained that companies with strong balance sheets could prosper down the road.

"Some of our outperform stocks -- Range Resources, Southwestern, Ultra Petroleum -- companies that have that lower cost structure, generate higher returns -- we feel that ultimately will be reflected in their valuation," Byrne said.

While no one knows exactly when the business will improve, Goldman Sachs analysts said this week that natural-gas capital budgets are now down nearly 50% from year-ago levels while rig counts have dropped to 900 now from 1,600 over the past summer.

Natural-gas prices may start to climb after natural-gas production peaks by March or April of this year and supplies dwindle if the economy improves.

"While we are not calling a V-shaped bottom in natural gas at present, we believe we are moving closer to a bottom," Goldman analysts said while upgrading Chesapeake Energy and Newfield Exploration to buy from neutral.

"Gas demand remains poor, but we believe it's now improving," Goldman said, amid optimism that stocks now trade "within range of a bottom" even with natural gas selling between $4 and $5 per thousand British thermal units.

So as the natural-gas industry's winter of discontent wraps up, Wall Street finds itself hoping for a thaw in the coming months. No one, of course, can say exactly when that will happen.