Week Ending December 10

WTI rallied the most this week in nearly three months as worst-case scenarios around the Omicron COVID variant subsided. Oil futures settled at 71.67 on Friday, up $5.41 on the week.

U.S. crude’s move back into the low seventies comes after the early indications that Omicron’s virulence is comparatively “mild” even though it might be as much as 4.5 times as contagious as the Delta variant. A less severe variant would likely result in less restrictive lockdowns or mobility restrictions that could have reduced crude oil demand.

Despite this, uncertainty still hangs over the crude market. Oil prices have been a political issue. Higher energy prices have been the target of oil-consuming nations and have resulted in releases from strategic reserves. The Biden administration could take even further action to try to lower gas prices. An extreme, but unlikely, move would be to ban oil exports. For more on this topic, check out our recent post.

There are many uncertainties both on the demand and supply side, so expect some price volatility. Hedging recommendations remain swaps for Cal 2022 due to the nature of uncertainty. We believe the globe will likely face medium-term supply issues, so we recommend collars for Cal 2023 and beyond.

Natural gas’s 20c drop this week seems tame compared to previous weeks’ moves. Nymex gas settled Friday at 3.925, down from $4.132 last week. Weather remains king, and changes in forecasts one way or the other is causing volatility. The early warm start to winter has made double-digit Henry Hub prices improbable. But, there’s still time for excitement. It’s only December 10; a move to cooler temperatures over the next two months could still lend support to the remaining winter strip and next two seasons.

What about next summer? Is Summer 2022 appropriately priced at $3.78? In our opinion, it comes down to what you think gas production will do next year. Right now, if you statistically control for weather (as AEGIS models do), the supply-demand balance looks tight relative to previous years. Nearly 2 Bcf/d of new LNG capacity is coming on next year, but will gas supply outrace the new demand? The trajectory of associated gas growth from the Permian and dry gas growth, mainly from Haynesville, marks our two bearish-potential factors in our Factor Matrix (link).

A mismatch between production growth and demand growth may be both bullish and bearish in 2022. U.S. gas production will grow in 2022, and we think the market understands this. But if production surprises to the upside versus market estimates, prices will likely slip, following a looser supply-demand balance. But timing matters, too. In the past, when storage levels are trending higher and away from the five-year average, prices typically fall. The reverse is true: when the deficit to the five-year average is expanding, prices usually rise. Production’s pace of growth may not match that of LNG’s, so we may see price swings in 2022 due to this evolving balance.

AEGIS hedging recommendations remain collars. This universal recommendation, regardless of tenor, is rare. Call-skew is still present year-round and is providing an extrinsic benefit to those who employ collars versus swaps. However, if the higher floor is the goal, or you believe prices will soften, swaps can still be good additions to the portfolio.