Week Ending October 29

Oil prices are up 10% for the month of October, driven by recovering demand, a tight S&D, gas-to-oil switching, and low crude inventories. WTI crude has moved into steeper backwardation late in the month more than in recent history. Strong physical demand at Cushing has increased the backwardation of WTI from 9% at the beginning of October to an unheard-of 15% for the 12-month time spread.

Three things are making us less concerned about near-term bearish surprises. First, the COVID threat has dissipated, and oil-product demand has recovered in North America and Asia, as measured by Apple mobility data. Second, in late October, physical-market strength has suggested that the market is even tighter than it was in the last several months. Third, OPEC continues to affirm its conservative approach to bring back supply. OPEC seems unwilling to surprise the market with more production than promised, per their latest sub-committee meeting.

What remains bearish for the next several months? Our biggest flag remains a stall in the overall economy. Second, to a less extent, is a rally in the dollar. In summary, there are few near-term bearish factors.

The December contract started Monday with a bang, rising 60c to $6.05/MMBtu on cooler weather changes. But, it was mostly downhill from there as gas settled Friday at $5.42/Bbl. Weather forecasts moderated throughout the week, keeping with below-average temperatures but not as bullish as Monday’s showing.

AEGIS recommends costless collars as the primary hedging structure for most clients. Why are we pushing collars as your first hedge consideration? They’re such good value right now because of call skew. In fact, swaps are so inferior, in our view, that they need a solid defense if selected.

Why use a collar instead of a swap? Imagine you flipped a coin, and if it lands on heads, the price drops 10% lower. If it lands on tails, prices rise 10%. You might not want to risk the downside for equal reward on the upside. But, if you get to flip the coin twice for a chance of tails, you might take that risk. That’s similar to what the options market is giving you in a costless collar.

Collars aren’t just for winter anymore. That coin-flip phenomenon is called call skew, and it’s normally a winter phenomenon. But it has now progressed into a “fear” premium next summer. It’s rare.

Without any opinion on fundamentals or the future of price, collars can still be a good idea. You don’t have to be bullish. Of course, there are exceptions and good reasons for utilizing a swap. Clients acquiring producing assets usually prefer the certainty of swaps if prices are near where budgets or promised cash-flow numbers are endangered.