Week Ending October 8

West Texas Intermediate traded above $80/Bbl for the first time since 2014 this week. Bullish sentiment has lifted oil prices by over $10/Bbl in the past month. The latest uptick comes as the globe moves past the demand impact from the COVID Delta variant, and OPEC+ confirmed a slow drip of production increases into a market hungry for supply. The optimism surrounding WTI can be seen in the options market, where call options (which pay out if prices rise) were much more bid than put options (which pay if prices fall). What had been “put skew” briefly switched to a small “call skew” on Friday.  The call skew is uncommon, and it's a benefit to producers. Those who have considered using costless collars may want to take another look, as this phenomenon makes collars more beneficial.

Call skew tells you something else. A put skew can be interpreted as the market’s expectation that price declines are more likely than price increases. Historically, put skew is more common. But call skew would imply the market thinks prices would be more likely to rally.

Fundamentals support the idea currently inherent in options skew. In the near term, there are more scenarios where the oil market could move higher. In our view, many of the bearish flags (see our Factor Matrix) are now less threatening as imminent risks, but rather medium or long term risks. Oil prices have tailwinds. Consider OPEC+'s conservative management of the oil market in terms of supply and the demand boon oil should receive this winter in Europe and Asia from gas-to-oil switching. The colder those continents get, the more oil prices could benefit.

AEGIS hedging recommendations remain swaps, with the outright price being quite attractive for producers. A common strategy implemented in the face of a rising market is to layer hedges to "average up" as prices continue to rise. This method will allow clients to de-risk systematically and protect against getting caught off-guard if the market turns lower. Trying to time (read: “guess”) price tops can often lead to reactionary fear-based hedging if the market retreats.

There was plenty of volatility in natural gas this week, but the result was Friday's settle at $5.565, only 5.4c lower than a week ago. The November contract reached $6.31/MMBtu early in the week but retreated from this 12-year high.

The outlook for winter gas prices can be segmented into weather scenarios. In our base case, which assumes winter is consistent with the last nine years’ average, gas storage would end near 1.5 Tcf to start April 2022. It's difficult to postulate how the price would react to a "normal weather winter," but it's likely that overall, price relaxes a bit. It is our opinion that forward prices for this winter are inflated, based on the demand-side fear of scarcity.

Our more bearish scenario assumes total degree days are 5% below the recent average. In this case, end-of-season storage lands near the five-year average, and we would expect prices to soften in response.

Last, a 5% increase in total degree days from normal could deplete storage to about 1 Tcf in a below-average or cooler winter. Winter prices would likely realize higher than the curve, as repeated cold forecasts would provide fuel to the bid side. But this would have repercussions for summer and next winter, too, as Summer ’22 would start at a severe deficit.

Our cold scenario, or one even colder, is what traders seem to be positioning against. The sky is the limit if winter is cold, and the market “fear premium” reflects that.

AEGIS hedging recommendations remain costless collars across the curve. Call skew is providing an opportunity to producers that is usually not as pronounced.