Week Ending June 11

Oil prices rallied for the third consecutive week; WTI settled on Friday at $70.91/Bbl. Although the price trend remains up, there are still three near-term price threats to consider. First, many forecasts of global oil demand recovery through 2H2021 are very optimistic. If demand projections fall short, then prices will respond. Second, Iranian nuclear talks continue to drag on, but a deal that would remove sanctions on its oil seems likely. Third, outside of Iran, OPEC supply increases and the timing of such increases is unknown past July. Up until this point, OPEC has been very good at managing this market’s oil supply.

Bullish risks remain beyond the short term. For example, has there been, and will there be, enough investment in oil development to serve demand in 2022 and 2023? Many are forecasting OPEC to start running out of available spare capacity at some point in 2022.

According to Bloomberg, OPEC will only have about 5.6 MMBbl/d still sitting on the sidelines after July. For U.S. shale, most public companies are still expecting zero to limited production growth as they focus on generating more free cash flow.

AEGIS hedging recommendations reflect the expected pace of each of the three risks mentioned above. For the balance of 2021, swaps are still our first choice. Prices are at two-and-a-half-year highs and already above key price levels for most producers. In 2H 2022, collars provide upside for producer exposure to a possible global supply shortfall. In the tenor gap between 4Q 2021 and 2H2022, the right hedging choice is especially dependent on client goals, the state of the client’s hedging portfolio, and their risk tolerance. A swap or collar can be attractive here.

We are ending our bullish outlook for natural gas. We are not waving a checkered or a red flag, but a yellow flag. Supply and demand remain supportive for prices, but we think the curve has corrected to reflect this reality. It is possible prices could move higher if the gas market is helped by weather or some surprises (see our Factor Matrix). However, there is resistance in the power sector if prices rise from here. At the current curve, we think most of the bullish factors are priced in.

Earlier this year, we expected prices to rise as winter weather faded away and the supply-demand balance was exposed. Storage figures from the EIA confirm that storage injections are close to the five-year average. Only the nearby tenors have risen enough for us to remove our bullish outlook. Beyond this winter, the curve is undervalued.

Some recent bullish forces may be short-lived. Henry Hub prices have received a short-term boost from the reduced southbound flows on TETCO toward southern Louisiana. On Thursday afternoon, Texas Eastern (TETCO) announced that the earliest their 30-inch line would return to full pressure would be late 3Q 2021. See our post here for more information.

Turning focus to next summer, with the Summer 2022 strip at $2.79, is it still “discounted”? We believe next summer’s supply-demand balance should be very similar to this year.  There could be 2 Bcf/d of production growth from the Permian and Haynesville combined. Yet, thanks to LNG and exports to Mexico, demand could easily rise by the same amount year-over-year. Therefore, Summer 2022 could still be undervalued despite its recent trek higher. For comparison, the Jul ’21 contract is trading about 50c higher than the Jul ’22 contract. We note that some of this price spread is attributable to an artificial boost from the pipeline outage on TETCO. Still, we think Summer 2022 has room to rise.

Since our neutral stance is more near-term focused, our default hedging recommendations have only minor tweaks. For most, we suggest hedging the remainder of the Summer 2021 strip with swaps. For Winter 2021-2022, we suggest swaps if you agree with our fundamental view. However, a costless collar provides free exposure to higher prices, due to call skew. Next summer, collars are probably the better structure. Some clients elect to use wide collars because they can set their floors in the $2.50s and leave upside into the $2.90s. For Winter 2022-2023, we continue to recommend collars.