Week Ending July 2

In one month, the August WTI contact has moved to $75/Bbl, up from $69, with a fresh round of gains from news out of OPEC this week. However, the OPEC news could end up being a mixed result, not clearly bullish as the market perceives.

In Thursday’s OPEC+ meeting, a deal was almost at the finish line, when UAE halted the process with a de facto ultimatum. That’s a lot of unnecessary Latin to say that they blew it up. Instead of a slow production increase through year-end, UAE’s demands would mean none of OPEC participants would increase production unless UAE gets to increase their own by 700 MBbl/d than previously negotiated. As you might expect, there are some unhappy OPEC members. Read our post here for more details.

The importance to the market? With no new deal, OPEC+ production could hold flat for a few months while demand continues to rise, adding to bullish fundamental forces. However, the other outcome is that there is a threat of a sudden rise in production in 2Q2022 as the current deal expires and OPEC+ production all flows at once.

We don’t know how this OPEC+ meeting will end (they reconvene on Monday), or what will happen at the next monthly meeting. But what we do know is that these prices are attractive to most of our clients.

As a result, we reiterate our recommendation to weight hedges toward swaps rather than collars for the balance of 2021. The deeper into 2022 you look, the more attractive collars are, in our view.

Everything (almost) has been going right for gas prices recently, so we are wary of a pullback. Record heat in the West helped gas demand, which was already being supported by drought and lower hydroelectric power output. Meanwhile, infrastructure disruptions in the Northeast have been keeping some supply off the market. It has been hot in the Northeast, too.

This rally makes costless collars a very attractive option for many clients, and it is no longer isolated to this winter. Next summer’s strip, the dog of the curve for so long, is now near $2.90, and collars there make sense for many. Here’s how it’s breaking down:

For this winter’s Nov-Mar strip, trading at $3.656 (intraday Friday), a sample costless collar was $3.40 X $4.24, meaning you could set a floor at $3.40 and participate in prices all the way through $4.24. Not only is the cap at an eye-popping level, but the skew is in your favor. That’s 26c of downside protection, but exposure to 58c of upside.

But here’s the new wrinkle. Summer ’22 (Apr-Oct) was trading at $2.889, and a collar with a floor of $2.75 would yield a cap of $3.04. That’s SUMMER CALL SKEW. You are rewarded with more “extrinsic” value in the call option (I won’t call it free money, but some would) than in the put option.

Further, that $2.75 floor is near where many of our clients either budget or plan their financials. If your financials tolerate a lower breakeven price, then how about this? Set the floor at $2.65 and that increases the cap to $3.15.

Next winter has call skew, too, and the recent rally is making it look like a great way to start 2023 hedges if you are behind schedule.