Week Ending April 14

Oil jumped over 11% since Monday’s close of $94.29/Bbl to settle Friday at $106.95.

Worries about Chinese Covid-19 lockdowns eased this week, helping prices rebound from demand worries. Also, there were signs that China’s central bank may take some monetary measures, such as cutting its key policy interest rate for a second time this year and reducing the reserve requirement ratio, both in an effort to boost its economy.

The European Union is moving closer to adopting a ban on Russian oil, previously thought unworkable. The new phased-in proposal of moving away from Russian purchases comes after Vladimir Putin vowed to continue the invasion of Ukraine. A European embargo on Russian oil would disrupt crude flows and likely reduce global supply if other Putin-friendly nations cannot step in as buyers.

Price risk remains to the upside for oil. The near-term may be pressured by historic reserve releases from oil-consuming nations, but losses from Russian exports could offset this. The globe will likely be short on supply amid already low inventory levels in the short- and medium-term. OPEC has yet been willing to accelerate its own production beyond current member quotas, and even then, the group only has so much it can produce. The U.S. oil industry, which ordinarily would have responded with aggressive growth at the current oil price curve, maintains capital discipline. Even if the U.S. does switch to production growth, it’s supply would arrive too slow to fill the gap until perhaps 2023. Therefore, the lack of future supply and growing demand profile should help keep oil prices elevated.

Call-skew remains in WTI for the balance of the year, and we continue to recommend hedges utilizing the costless collar. The collar will allow for upside. It is consistent with the more bullish view described above, and it can capture the options-pricing irregularity that is call-skew in the crude market. Our recommendation for collars in 2023 and beyond is more of a function of bullish sentiment rather than skew. Call-skew dissipates starting in early 2023 but shouldn't sway producers from entertaining the collar.

Natural gas has continued to rally past $7, and the prompt contract is now at its highest level since 2008. This is the strongest start for gas in any year, ever. The rally has extended beyond just the near-term tenors, with the Summer ’22, Winter ‘22/’23, and Summer ’23 strips all posting week-over-week gains of 74c, 76c, and 28c at $7.25, $7.34, and $4.693. To read our commentary on the rally in gas prices, click here.

Weather is not the cause. The weather has cooperated so far this month, but that doesn’t justify the $1.50 or 26% gain since April 1 – especially in springtime. The forecasted gas-weighted HDD total started the month at 331 HDDs before shooting up to a high of 367 HDDs, then falling back down to about 351 HDDs. This is average, falling right in between the 2020 and 2021 totals of 322 and 374 HDDs, respectively.

The rally is more likely the result of the market trying to re-balance itself. By pricing higher, there is some short-term demand destruction that would enable the U.S. to inject gas into storage at a faster rate.  According to AEGIS models, some demand losses are necessary to take inventories at adequate levels heading into winter. This would not be necessary if production were rising, but production has struggled to recover, and the market remains undersupplied.

The EIA reported a 15-Bcf injection for the week ending April 8. This contrasts with the 55 Bcf increase in storage during the corresponding week of last year and a five-year average injection of 33 Bcf. Total inventory levels stand at 1,397, or 303 Bcf below the five-year average. This EIA storage stat showed a slightly-looser supply-demand balance, but it could just be shoulder-season noise, and it would take a couple of consecutive, large storage prints before we can say this market is loosening.

Our trade recommendations are still collars throughout the curve. The current call skew in the gas market, which is well above historical norms, makes the structure too attractive to pass up. It allows a hedger to maintain maximum upside potential in the event of a prolonged period of higher prices while still protecting cash flows with the floor price above levels required by most budgets.