Week Ending August 20

Oil prices suffered a 9% decline on the week to settle Friday at $62.32/Bbl, a multi-month low. Following WTI’s $13/Bbl drop from July 13 high, it’s time to reevaluate the state of the oil forward curve and look at hedging choices.

There is no doubt now that oil’s 40-week price trend has ended and has quickly moved down (see more on Trend, Location, and Control here). There’s good news, however: hedging now lets you participate in almost 80% of the rally that started in November 2020.

AEGIS has been warning about potential price vulnerability for the balance of 2021. We have emphasized that the market is vulnerable to demand disappointments. Market sentiment regarding demand recovery has seemed very optimistic. Anything that threatens demand affects price, especially in 2021.

We believe swaps, with their superior price protection, have been the right choice, even as the global supply-demand balance has been tight.

Collars were a luxury for most of this summer when the forward curve priced higher. Why a “luxury”? For collars to be viable, beneficial hedges, oil prices must be higher than what budgets require. Collars are an opportunity to risk a small pull-back in price to potentially have exposure to higher prices.

But now, oil prices have now moved lower across the curve. A month ago, Cal 2022 swap was $66.87, and a possible collar was $60 X $72.41. Now the Cal 2022 swap is $59.36. We urge clients to set floors according to financial goals; for many, our recommendation is to choose a swap rather than a collar for this reason alone. 

Hedge while you still have a goal to protect. Are prices above what you need? If prices drop below what is required to reach your goals, you’ll be forced to underachieve or revise goals. According to the Dallas Fed Energy Survey, the forward curve is near important price levels for producer profitability. Per the survey, WTI prices across all basins need to be at about $52/Bbl for the average producer to have enough profitability to drill a new well. Permian survey responses said that number was closer to $50/Bbl.

If you, like the respondents in the Fed survey, need similar price levels, please discuss with your AEGIS strategist a course of action to protect your individual goals. Many clients will need to be very precise. Adding hedges in 2022 and 2023 requires a close look at your budgets. Some will want to lock in prices if they fall further, while some may need to narrow the collars.

Natural gas finished the week at $3.89/MMBtu, down 9.6c on the week. There hasn’t been much change in the fundamentals as the gas market remains undersupplied, and the supply-demand fundamentals have not changed much. But, we’re getting closer to fall, and with it comes more chances of demand disappointments. We have likely already reached peak seasonal gas demand for power. Normal temperatures will now every day into the fall.

It is hurricane season, so we added seasonal hurricane risk to our Factor Matrix this week to capture the threat that storm damage can have for LNG facilities on the Gulf Coast. Last year, the 2 Bcf/d Cameron LNG facility in Louisiana was knocked offline or forced to export at reduced rates due to damage caused by Hurricane Laura.

AEGIS hedging recommendations remain collar-heavy throughout the curve for producers except for the short (two-month) balance of the Summer 2021 strip, where we see swaps as the better choice.

The collar recommendation is for two reasons. First, an abnormal amount of “call skew” (call options are more expensive compared to put options) present in the curve causes option structures to be more attractive or beneficial for a producer. Second, AEGIS believes that prices in 2022-2023 could realize higher than current levels and upside-friendly hedging instruments would allow for more upside participation beyond this coming winter strip. In contrast, we recommend consumers derisk their exposure with swaps, and avoid collars.