Crude oil extended gains from last week’s rally to finish at $83.82/Bbl on Friday, January 14. West Texas Intermediate has surged over 11% since the start of the new year.
Oil’s rally comes amid signs the market is tightening; the global demand impact looks resilient, hardly affected by Omicron. Global supply outages have also helped narrow supply-demand balances globally. A wider spread between the second and third WTI contract month (M2-M3) could be corroborating evidence that the oil market is short supply. WTI’s month-2 contract was trading at a 90c premium to month-3 as of January 14, a 60c improvement in the last thirty days.
Global unease regarding Ukraine and the possible Russian incursion has stirred up some measure of geopolitical risk. The Wall Street Journal reported that Russia began moving tanks and other military equipment toward Ukraine from its Far East bases. In addition, a U.S. official told CNN on Friday that Russia has prepositioned a group of operatives to conduct a false-flag operation in eastern Ukraine to create a pretext for invasion. Because Europe depends on Russian gas that traverses Ukraine, the crisis immediately threatens natural gas prices. But it is not as well known that Russian oil also transits through Ukraine, and the threat of an armed conflict could boost oil premiums.
AEGIS oil-hedging recommendations remain swaps for the balance of 2022 and collars thereafter. Collars allow upside participation, but they also mitigate backwardation in the curve (the outright swap in 2023 is over $11/Bbl lower than the prompt month). There are also fundamental reasons to prefer collars. Many analysts question if there will be adequate oil supply farther into the future. To us, there is an implicit upward risk-skew for oil prices in 2023, if not sooner.