Week Ending August 6

WTI gave up over $5/Bbl this week, as rosy demand-growth estimates were questioned in light of the global resurgence of COVID-19. September WTI futures closed at $68.28.

We acknowledge the tightness in the physical oil market, and that OPEC+’s recent announced plans to only gradually return held-back supply would likely keep the market tight in the short term. However, we still believe that traders have been assuming quick demand recovery and perhaps had overdone their buys. This, in our view, led to a price that was positioned for disappointment.

Or, alternatively, traders are being especially quick to sell into a market that they think is overbought. Either way, oil prices this week again showed themselves vulnerable to sudden weakness.

We continue to recommend to most clients a more aggressive hedging tactic of using swaps rather than options structures for any outstanding exposures for the rest of 2021. Especially on rallies, take advantage of the best prices in years, because the last few months have shown these short rallies might not last.

Beyond 2021, our recommendations depend on your situation. For those oil producers whose budgets work at lower prices than the current curve, options structures such as costless collars may be appropriate for 1H2022. For 2H2022, our view is that the market has a chance to be acutely undersupplied as OPEC returns most of its supply and demand is more likely to have recovered. Costless collars or other options structures become more attractive.

One last note: Our notes on preferred structures (swaps versus options) says nothing about volumes to hedge. The amount of hedges depends on your financial goals; our clients’ goals cover a large range of both ability and willingness to tolerate price risk. A tailored approach is always wise, and we want to have those conversations with you.

Natural gas this week clawed back all its 13c loss from last week, then added 24c more. The prompt contract (September)closed at $4.14, marking its best Friday close since December 2018.

Gas fundamentals remain strong. Only one thing has surprised us about the supply-demand balance: power-generation demand. Usually, gas demand decreases swiftly when prices rise so much. But this year, the old relationships have broken down, and gas-fired power generators are burning more gas than they normally would have. The cause seems to be a matter of geography – most of the heat this summer has concentrated in the U.S. West, where fewer coal plants are available to compete with gas for increased electricity demand.

Our default recommendations for hedging structures are swaps through November and collars beyond.

“November” may seem odd to many readers, because the November contract is actually part of the winter strip, while October is still “summer.” Our reasoning is that November is especially sensitive to weather.

The other winter tenors, December through March, are also vulnerable to weather changes. However, those months give such call skew (where call options are more expensive than comparable put options), that costless collars become more attractive for a producer hedger than swaps, in our view. Gas consumers will want to avoid collars, and we have strategies that give you protection without overpaying for it.

Looking to 2022: It’s earnings season, and we are watching closely for news of dry-gas and associated-gas (oil) producers’ plans for 2022. If supply doesn’t increase, next year might have bullish potential much like 2021 has. Next summer’s prices are severely discounted versus this year’s.