Week Ending April 29

Snapping the three-week streak of consecutive losses, crude prices finally showed some signs of strength this week. The prompt-month (contract Jun '22) finished up $2.62 on the week at $104.69. Refined products are dragging energy prices higher. Fuels prices reached new all-time highs as inventories reached multi-decade lows. This week's rally comes despite a weak short-term demand outlook, thanks to China's recent COVID outbreak. A rally despite negative, transient news is a bullish signal, and it suggests that the sell-off over the last few weeks was likely overdone and not reflective of short-term supply-demand fundamentals. Perhaps the weeks-long dip in prices was the market exhaling and regrouping, given how much prices ran up in response to the news of the Russian invasion.

China has experienced its worst COVID flare-up since early 2020. As a result, China's energy demand has suffered after implementing new COVID-lockdown measures on 180 million citizens.

Beyond the COVID-related issues, China's crude-oil purchases are affecting global trade patterns. Its government has avoided sanctioned Russian crude to purchase sanctioned barrels from Iran instead. According to the Wall Street Journal, Iran's exports to China peaked at 870 MBbl/d in March, compared to the 2021 average of 668 MBbl/d.

OPEC is set to meet next week, and most observers agree the cartel will proceed with its planned supply hikes. The group is currently producing around 700 MBbl/d less than their quota, thanks to a few struggling members, namely Angola and Nigeria. The cartel has serially fallen short of its output targets.

U.S. distillate inventories are at their lowest since May 2008. Combined diesel and jet fuel stocks fell by 1.4 MMBbls to 107.3 MMBbls last week. Part of the decline can be attributed to the increased worldwide demand for U.S. petroleum products. After Russia's invasion of Ukraine, U.S. export volumes have swelled. The heightened global demand, low stocks, and limited refining capacity have created the perfect set-up for higher retail diesel prices. Diesel is now at all-time highs, above $5/gal. That's more than twice the average retail price of $2.20/gal since January 2010.

The oil curve remains undervalued by our estimates. Our hedging recommendations are similar to last week's, with collars throughout the curve. The call skew (that is, the implied benefit of using a collar structure rather than swaps) has fallen off by quite a bit. The upside-to-downside ratio of collars is still very attractive, and therefore we recommend taking the opportunity being provided by the market., Meanwhile, backwardation (downward slope) has decreased in the forward curve. This means that a producer does not have to set their floor prices a lot lower to enjoy access to potentially higher prices still.

Gas has been volatile this week, trading in a range of around $1 from $6.40 to $7.40. Some of the volatility is likely being driven by supply disruptions earlier in the week in the Bakken and Appalachian regions; output slipped 2.5 Bcf/d lower. The May '22 contract rolled off at around $7.267 on Wednesday, the highest contract settlement since at least 2008. However, the newly-minted prompt month (Jun' 22) finished nearly 10% higher at $7.244.

Gazprom finally shut off flows to Poland and Bulgaria this week as the two countries refused to comply with the Kremlin's demands to pay for gas in roubles. However, Russia did provide countries the option to open an account at Gazprombank to comply with the request, where the bank would handle converting currencies to the rouble. However, the European Union issued guidance that declared any country that complies and creates an account with the Russian bank would be in breach of current sanctions. Four European countries had opened accounts before the EU guidance, but the rest are looking for new sources of supply if Russia further withholds gas.

Still, the turmoil in European markets is unlikely to impact domestic gas prices directly. U.S. LNG exports are already near capacity. Increased global demand for U.S. gas does not create a bid in the U.S., because there is no more gas to bid on. LNG throughput is firm despite maintenance at the Freeport facility over the last couple of weeks. That facility's problems are offset by increases elsewhere. Calcasieu Pass commissioning is progressing, and flows reached a new record high of 1 Bcf/d on Friday, only around 0.3 Bcf/d below its capacity. The maintenance season approaches, though. In the coming weeks, we could see some fluctuation in demand as companies bring trains and pipelines down for maintenance. 

AEGIS recommendations continue to be costless collars throughout the curve. We are recommending collars for most clients unless there is a need for a higher floor price. Production growth looks unlikely in the near term, which means upside price action is more likely. This upside-risk sentiment has also shown up in the options market; call skew is strong through the next four seasons. The call skew is simply too good to pass up.