Amazon has been gaining ground on Netflix as the most popular video streaming service in the U.S., and now it is planning something that could see it overtake its rival. According to a report in the New York Post, the e-commerce giant is preparing a free video service. Supported by advertising, it would sit alongside — not replace — the company’s existing video offering that is bundled into its $99/year Prime membership.

Does this sound familiar? It should.

In March, the WSJ had a similar report describing an Amazon free, ad-supported video service. At the time the company flat-out denied that this was happening.

“We’re often experimenting with new things, but we have no plans to offer a free streaming-media service,” an Amazon spokeswoman told Variety in response to the WSJ report. The NYP report notes that the ad-based service is “a definite go” but does not specify a launch date.

Asked about the latest report from the NYP, Amazon spokesperson Sally Fouts has given us a comment that has moved on from “no plans” to “nothing announced.” From her email:

“We currently offer the first episode of some television shows free with ads through our First Episode Free feature on Amazon Instant Video, and there are display ads on some short videos such as movie and game trailers. We’re often experimenting with new offers and experiences for customers, but we have not announced any plans to offer an ad-supported video streaming service.”

The First Episode Free feature that she is referring to lets users stream first episodes of select TV shows for free (with ads), as a way of enticing viewers to pay for more. Launched in June, this covers hundreds of TV shows, and comes on the heels of smaller versions of this program for Amazon services delivered through specific devices like the Kindle Fire and Roku.

That limited free service could be the company dipping its toes into the water, trying out the format to see how well it works and how many people are using it to watch videos. I’d suspect that Amazon has seen good take-up, hence the plan to offer a bigger version of it.

There are a lot of reasons why it would make sense for Amazon to launch an ad-supported video service:

For starters, it would give Amazon a very obvious way of growing its existing advertising network.

The Amazon Media Group, as the company’s effort is called, already sells advertising across a range of Amazon properties — Amazon.com, Quidsy, Imdb.com (planting seeds for film and video-related ads?), and photography site DPReview. It also runs mobile ads and ads specifically for Amazon’s Kindle devices. It’s estimated to be bringing in at least $1 billion in revenues already.

Adding a video ad service would give Amazon more inventory for its ads, and a free video service could be one more way that Amazon could promote sales of its devices — don’t forget that the Kindle Fire tablet has long been marketed as a video/media consumption device.

And it could be another way for Amazon to market services to that portion of the population who have not been won over by the company’s all-in Prime membership scheme, which this year saw the price go up for the first time ever, to $99/year from $79.

More generally, video ads have become a very coveted space of late.

Advertisers love them because consumers love video, and so the ads are served to a more captive audience; and because they are a much catchier way of getting a message across than banner and search ads.

Ad businesses love them because they represent a premium on banner ads in terms of pricing, hence better margins.

Amazon will be wanting to tap into this same business model, too — and may well already be getting requests from clients to add video ad units into its existing mix.

Currently, the company only lists one video format in its list of ad units. That is for an in-stream video, which it only serves on non-Amazon sites, and only in the U.S. and Canada.

A move to expand its video offerings would come at the same time that companies like Google (which sees Amazon as its biggest competitor in another form of advertising: search) and Yahoo are also beefing up their video plays.

While Google’s YouTube has built its audience on ad-supported free video, it also has paid channels and is now launching a paid subscription for music videos, Music Key. While Yahoo has long been building a more comprehensive video play in the form of content, it’s also been beefing up in video ads, recently acquiring BrightRoll.

While Amazon dominates in e-commerce, it is a relatively new player in the media streaming business. Netflix has long dominated the subscription-based streaming market in the U.S., and a report published by network optimization company Sandvine yesterday noted that it now accounts for 34.9% of all downstream traffic, in peak evening hours.

“Amazon Instant Video is now the second largest paid streaming video service in North America, accounting for 2.6% of downstream traffic,” Sandvine notes. It’s also seeing the most growth, with traffic more than doubling in the last 18 months.

While an ad-supported, free video service would be a departure from a paid tier, it could help Amazon introduce more users to its video features and potentially upsell them to the more lucrative, longer-term contracts — a tactic that the company has been well known to use in the past.

Updated with Amazon’s response.