February 4, 2022

West Texas Intermediate gained $5.50 this week and finished at $92.10/Bbl on Friday, the highest level since late 2014. A year ago, it was $56.23. A multitude of bullish factors are driving price higher: low inventories, geopolitical risk premium, OPEC+’s production underperformance, and strong demand.

OPEC and its allies affirmed previous plans to increase their output for March by 400 MBbl/d on Wednesday. But, several of the OPEC+ countries have continued to pump below their quotas. Oil market bulls took the OPEC decision as a buy signal; many thought OPEC+ could lift quotas by more than 400 MBbl/d in the face of $90 oil. How much spare capacity does OPEC+ really have? The answer will be very important later this year as demand continues to recover and grow. Many bullish calls on oil for 2022 and especially 2023 are based on skepticism that OPEC+’s can deliver enough oil.

WTI’s backwardation is signaling a very tight oil market. Traders are willing to pay nearly a $2/Bbl premium for the prompt month over the second month WTI. Monthly spreads for the next seven months (M1-M2, M2-M3, M3-M4, and so on) are all over $1/Bbl. Some call this “super backwardation,” as the downward slope of the first 12 months of the curve is the steepest it’s been in at least the past 20 years. The amount of backwardation means oil for immediate delivery has more value, so it is a signal that the market is increasingly getting tight. Steep backwardation can look punishing for a producer looking to hedge as further along the curve as prices are much lower than today’s $90/Bbl. There are some different ways to approach this market structure; talk to your strategist for specifics.

AEGIS hedging recommendations remain swaps for the first half of 2022 and costless collars for the remainder of the curve. Prices have run up to seven-year highs and may have many bullish factors priced in. We suggest swaps in the near term because of this. However, some clients are considering near-term put options. Even though volatility is high, and put premiums are also mathematically high, they are still attractive to some. Puts provide an absolute floor, while maintaining exposure to even higher prices, should they occur.

There were plenty of fireworks this week in the gas market but little change in the week-over-week settle. The March contract fell 6c on the week to finish on Friday at $4.572. But, not before rising 75c to $5.50 on Wednesday and giving those gains back over the following two days. Gas’s volatility came as traders positioned ahead of a swath of arctic air blanketing the U.S., giving flashbacks of winter-storm Uri almost exactly a year ago

Fundamentals for gas remain bullish, because supply has not been keeping up with demand. This type of setup usually results in an upward skew in price response.  Prices race higher when cold weather threatens.  A cold January and forecasted cold February are a stark contrast to early winter weather. The below-average cold, coupled with bullish underlying fundamentals, has created large storage withdrawals. So much so that analysts were expecting to exit the winter season with 1.65 Tcf in storage back in December. However, large storage pulls have moved the estimate closer to 1.2-1.3 Tcf for the end-of-season. The move from 1.65 to 1.3 Tcf has implications for summer and even next winter. Hence, the upward movement in the forward curve.

AEGIS hedging recommendations are collars throughout the curve. There is an abundance of call-skew, making collars attractive. If we have to point out a weak spot in the curve, it would be the Summer 2023 strip. In 2023, production is likely to increase, but there is almost no hope of new LNG demand, the engine of gas-demand growth over the past five years.