Last week, the Baker Hughes gas-directed rig count declined by 80. The yearend gas rig count of 1,267 is decidedly lower than expectations, says Stephen Richardson, analyst at Morgan Stanley & Co. Inc. A decline in the horizontal rig count (down 27 last week) is likely "to address a concern of the bears that the rig count decline had been centered upon less productive vertical rigs," he says. The size of the decline was likely aided by yearend contract expiries, suggesting the pace will moderate by mid-January. "We continue to expect a 500- to 600-rig decline to drive flat production in '09 and address the near-term oversupply facing the market." Meanwhile, the EIA October supply and demand data was somewhat obscured by post-hurricane recoveries. A key industrial segment demand was up about 10%, sequentially, as refiners returned following the hurricanes, but was still 4% below the five-year average. Weaker gas demand in the industrial and utility segments was offset by stronger commercial and residential demand, Richardson reports. Commercial demand totaled 5.9 billion cubic feet per day, up about 16% year-on-year and 5% above the five-year average. Residential demand was 6.9 billion cubic feet per day, up 22% year-on-year and in line with the five-year average. Lower-48 wet gas production for October was 60.9 billion cubic feet of equivalent per day, up 7.6% sequentially and 4.7% year-on-year, as production from the Gulf of Mexico and impacted onshore areas returned to production after the hurricane. Supply from Texas (up 16.5% year-on-year) and Wyoming (up 12.8%) dominated growth trends, while the impact of wider mid-continent basis differentials likely contributed to declines in Oklahoma, down 3.4% sequentially and 0.9% year-on-year. "Where do we stand? Strength in E&P equities may continue to be driven by broader market optimism, a potential bottoming in commodity price, particularly in crude where consensus expects OPEC cuts will improve balances, and supportive seasonal weather patterns," says Richardson. "Natural gas will continue to face challenging balances in the first quarter of 2009, particularly as weather comps become more challenging in February and March, and demand weakness looks likely to continue."