Week Ending May 7

Oil prices still walk a balance between ongoing supply shortages (mostly because of OPEC+) and pessimistic COVID-19 news in Asia. So far, the supply side is winning. Demand in the West continues to improve, and OPEC+’s small production increases this summer are not weighing down price.

An impending news item could be Iran. Proxy discussions between U.S., Iran, and other countries may yield a return to the nuclear deal, initially arranged in the Obama administration. Trump had exited the deal and replaced it with sanctions, including a ban on oil sales. That means Iran might have over 1 MMBbl/d (maybe 1.5 MMBbl/d) of supply waiting if a new deal is struck. See our Factor Matrix, where we ascribe a “bearish surprise” warning.

Otherwise, we still are wary of the rest of OPEC+’s spare capacity. Comparing expected production to historical production, there could be 6 MMBbl/d of extra capacity this summer. The availability of that capacity (it’s been a while since they produced at those levels) and OPEC+’s choices on timing both could suddenly add bearish pressure to price.

Our default hedging recommendations for most clients are swaps, rather than options structures. As prices have escalated, swaps are tactical tools to increase your weighted-average floor price and protect your budget. Further, as Cal 2022 and Cal 2023 are near $60 and $57, extending your tenors can create a protective base layer of protection.

It took 6 ½ days for natural gas to pick a direction this week, but it’s ending the week up again. We’re encouraged by underlying fundamentals. Year over year, any demand measure looks good; May 2020 was a depressing month. But gas demand is expanding, and production has plateaued.

This market is probably 2 Bcf/d undersupplied. Cool summer? There’s no shortage. Production rises? No shortage. But if you believe supply is not likely to expand this summer, there is a strong chance of higher pricing before we get to next winter, in our view.

But prices have already risen, and for the reasons we pointed out ahead of the rally. How much more could gas run? Keep a watch on summer tenors’ pricing reaching closer to $3.15. Coal substitution still exists and could come into play.

Next summer is a conundrum. That strip is $2.60, and the backwardation between winter to summer is at a 10-year high.

Therefore, here are some default hedging recommendations, to be tailored to your own portfolio. If you could tolerate a lower price in Summer 2022, then consider costless collars, where the floor is your minimum tolerable price.

For this winter, collars are the best choice. The cap value versus floor value is around 2:1, typical for winter. You are rewarded for risking some downside to try to capture upside.

Our bullish outlook does color those recommendations, and we recognize they are not appropriate for everyone. Your AEGIS strategist can counsel you on other possibilities that may better fit your book.