January 7, 2022

West Texas Intermediate rallied over 5% for the week ending January 7 amid multiple global supply outages. On top of that, unrest in Kazakhstan has added some measure of a geopolitical premium to oil prices this week as the country produces nearly 1.5 MMBbl/d. The Kazakhstan turmoil, coupled with Libya's 700 MBbl/d in supply outages, has fueled this rally and helped steepen the oil curve's backwardation.

Brent crude's backwardation has increased with the decreases in global supply. Increased backwardation is a signal of tighter supply. The prompt-spread (Brent Mar-Apr) traded at 70c/Bbl on Thursday, over double the 32c spread in early December. Most analysts expected some degree of oversupply in 2022, especially in 1Q2022. But a tighter physical market due to supply disruptions could delay or diminish the amount of excess oil depending on outage duration.

Making little noise at the beginning of the week was OPEC+'s decision to approve the previously agreed-upon plan to add 400 MBbl/d for February. The cartel held its official meeting on January 4 and agreed that the oil market could tolerate an additional 400 MBbl/d of supply. Approval of the supply increase was expected by most analysts, who also have suggested multiple members of OPEC+ will continue to have trouble meeting quota increases. Several members, including Angola, Nigeria, and Russia, struggle to reach their respective allocation quotas. As a result, several analysts have released what we consider bullish calls on oil prices, citing OPEC's inability to achieve its output goals.

AEGIS oil-hedging recommendations remain swaps for the balance of 2022. The conservative approach reflects unknowns as to how much oversupply the oil market will experience in 2022 and whether Iran receives sanctions relief. On the flip side, the further down the curve a producer is looking to hedge, we suggest deploying collars to allow for more upside participation; we believe there is more risk to upside from 2023 and beyond. It's also worth mentioning that our clients have shown increased interest in buying outright put options within the next six months, as less Theta (time-to-expiry premium) for these options makes them relatively cheap.

Gas markets started the year off with no major fireworks, trading in a relatively narrow range of around 20c. The bearish EIA storage report showed a draw of 31 Bcf for the last week of December – markedly lower than analysts' estimates of a draw in the mid 50's. 

December 2021 was the second warmest December in at least the last 20 years for the United States, with many cities recording all-time high temperatures for the month. In addition, lower-than-average storage draws for the month reflected the balmy weather, along with declining winter gas prices. The Winter 21/22 high price of $6.21/MMBtu was reached in early October. That mark was more than $2 higher than where we stand today.

The EIA storage reports over the previous two weeks hardly created bullish sentiment; however, we continue to argue that the temperature-adjusted supply and demand balance shows a structurally tight market. We also interpret this week’s price action as somewhat bullish: The lack of a dramatic price move on a horribly disappointing and surprising EIA storage report suggests there was little trader interest in selling gas lower. 

On the supply side of the equation, cold weather moved over the Rockies and into Texas last weekend, bringing a wave of freeze-offs. Production declines were primarily concentrated in the Permian, with some losses extending into the Rockies and Bakken. As freeze-offs in the West tapered, the cold weather and freeze-offs moved east to Appalachia. Overall, dry gas production was down an average of 2.5-3.0 Bcf/d week-over-week.   

Looking ahead, weather models are showing colder weather across the lower 48 and Canada, with an Arctic blocking pattern taking shape in the 15-day forecast. Long-range weather models indicate that colder temperatures should extend into February, mitigating the unusually warm December. Early estimates for storage draws for the next several weeks are all in the 150-200 Bcf /week range.

Summer '22 is $3.76 at the time of writing – the high end of the $3.50 – $3.80 range since the beginning of December. Call skew has dissipated but still exists. For those with summer volumes left, we are indifferent to swaps or collars and believe that corporate objectives and existing hedge portfolios should guide decision-making. Beyond the Summer '22 strip, call skew still provides enough value to make costless collars attractive. Still, downside risks loom as the timing and magnitude of production growth will be the largest wildcard for the supply-demand balance.