Week Ending December 3

Lately, multiple factors have been weighing on crude, but none more than the uncertainty surrounding the Omicron COVID-19 variant. Last Friday's $10/Bbl sell-off was the result of the crude market pricing in the worst-case scenario related to potential demand destruction from the newly discovered Omicron variant. Investment bank Goldman Sachs estimates that the sell-off was the equivalent of the market implying a 7 MMBbl/d decline in oil demand over three months. In other words, the price plunge was way overdone.

Coincidently, with Omicron's discovery, OPEC and its allies held their official meeting Thursday to discuss their supply policy. It was widely expected that OPEC+ would possibly forgo increasing supply in January following announcements that some oil-consuming nations would be releasing crude from their strategic reserves. Those countries are trying to combat high energy prices and COVID uncertainty. However, OPEC+ rubberstamped their 400 MBbl/d increase for January, but with a twist. They left themselves an out; the issue remains "in session," and they reserve the right to reverse that decision at any time. This is different from any previously taken action. It may set a floor for oil prices.

AEGIS hedging recommendations have shifted. We had suggested using swaps for the next six months and the mix of collars after that. We now recommend using a swap for all of Cal 2022 and collars in 2023 and beyond.

One reason for the change is that put-skew has dramatically increased as the market has turned more bearish in the last week. Heavy put-skew can make costless collars less attractive as the floor becomes more expensive than the offsetting call sold to complete the collar.

As one opportunity becomes less attractive, another presents itself. The steeper put skew has made three-way collars more attractive. Three-way collars are not for everyone. We know not everyone can, should, or would use them. For those who could, consider the following. As of Friday, a Cal 2022 three-way was $60 X $45 X $74 with a reference swap of $65.09. In other words, unless you believe WTI will trade below $45 next year, this addition to the portfolio could make sense. For 2023 and beyond, we prefer the costless collar due to what we believe are bullish fundamentals during this period.

Gas volatility has been an order of magnitude higher than oil volatility since Thanksgiving. Prompt-month natural gas (January 22) plunged $1.33/MMBtu to settle at $4.14/MMBtu for the week. The large premium winter gas had over summer gas has nearly evaporated. The March/April spread is now near +20c, down from +$1.80 back in early October. Concerns of a supply shortage toward the end of the withdrawal season have dissipated.

So what has happened? Why has January and the rest of the winter strip deteriorated so much? The short answer is the weather -- extremely bearish weather. Nationally, October was the sixth warmest in the past 127 years, and November was slightly warmer than the 10-yr average. But, the forecast for the first two weeks of December has been the most bearish. A warm start to this month will likely place this December in the top five- to ten-hottest of this millennium.

Warm weather is not what traders were expecting when the January contract traded $6.00+ a month ago. With January now trading at $4.14, that "fear premium" built into the coldest months of the year has retreated. 

Even though the weather has been bearish, fundamentally, the gas market is in good shape. Our estimates show that the daily supply and demand balance is still tight compared to previous years. However, weather trumps all else in the winter.

Despite the dramatic pullback in near-term pricing, AEGIS hedging recommendations for producers remain costless collars across most of the curve. The options market is still providing a benefit where most tenors carry some amount of call skew, making costless collars more attractive than a swap. However, swaps provide the most aggressive form of protection and result in a higher floor than collars. Clients are currently deploying a mix of these two structures.