The news on the natural gas supply front has certainly been impressive. On Wednesday, the American Gas Association reported storage increased by another 99 billion cubic feet (bcf) last week, pushing storage levels slightly ahead of last year. That's astonishing, especially considering the rhetoric during the winter months suggesting we could actually run short of natural gas.

The winter talk of shortages pushed natural gas prices through the roof and the stocks of exploration and production companies followed. Now, with near-record weekly injections, natural gas prices have tumbled, with prices breaking $4 per million British Thermal Unit (mmBtu) last week. Not surprisingly, E&P stocks have struggled. And, slackening demand for gas resulting from high winter prices and a slowing economy haven't helped the cause.

However, while it is very possible another couple of weeks of strong gas storage data may depress prices further, there is light at the end of the seasonal tunnel. Remember, we have cautioned since March that natural gas is a seasonal business and the "shoulder season" -- the period between peak winter heating demand and the emerging summer cooling demand -- could provide bumps in the otherwise bullish gas story. That's exactly what has happened.

But now we are closer to the beginning of a new era of summer gas demand, which should prove that the current increase in storage will not be permanent. "At this stage we still see electric power as the driver for natural gas and we're not alarmed by high injection rates, especially when storage facilities have low inventories and fuel switching and an economic slowdown have caused some demand loss," noted Merrill Lynch E&P analyst John Herrlin. "We view that as an intermittent and not a permanent event."

And, if demand picks up as anticipated, supply will once again be challenged to keep up. Herrlin and others estimate that domestic production of natural gas will only increase by about 1% this year, even with a near-record number of rigs laboring in the fields. That leaves little margin for error, especially if the summer heats up as many long-term forecasts suggest.

The psychology in the oil patch has changed in the past two months, from excessively optimistic to overly pessimistic. That change -- assuming supply gains are only temporary -- should provide a chance to establish or add to positions in the exploration and production sector. "Our bottom line is that current commodity price gyrations may accelerate mergers," says Herrlin. "Production won't grow much more than 1% in the U.S. in 2001 and demand will recover. ... Nevertheless, resource potential matters and we still view the stocks as being undervalued on that basis."

Easing Into Summer

I'm not much for calling absolute bottoms and tops so let's leave it at this. The market has become overly concerned about what appears to be a short-term problem.

As such, I would use weakness to begin to rebuild positions in the solid E&P names with gas exposure. The list would include companies like Apache (APA:NYSE - news - boards), Anadarko (APC:NYSE - news - boards), Burlington Resources (BR:NYSE - news - boards), Devon Energy (DVN:NYSE - news - boards) and Mitchell Energy (MND:NYSE - news - boards). That's a list of more stable, larger-cap names that should participate in any rally without providing a lot of risk on the downside.

Also, while they gained on the news of Conoco's (COC^A:NYSE - news - boards) bid for Gulf Canada, don't ignore the Canadian names like Alberta Energy (AOG:NYSE - news - boards), Talisman (TLM:NYSE - news - boards), Anderson Exploration (AXN:NYSE - news - boards) and Rio Alto.

Don't rush to the cage, but at least begin to think about how you can make money as natural gas demand heats up with summer temperatures. If the power pundits are right, gas prices will be back to $5 per mmBtu before we know it and E&P stocks are almost sure to follow.