Week Ending May 13

Week-over-week, the oil forward curve is nearly unchanged. But this week’s final settle didn’t come without volatility. Prompt-month WTI traded within a $12 range before settling at $110.49/Bbl on Friday.

High demand and subsequent low stocks for refined products (diesel, gasoline) have helped lift bullish market sentiment. Oil product cracks, a proxy for profitability among refiners, have surged as diesel, jet, and gasoline prices have moved higher, and faster than have crude prices. There is concern that there isn’t enough fuel-making capacity both in the U.S. and across the globe to meet the refined -demand. A lack of refining capacity could limit crude oil bullishness even as product prices run. The northern hemisphere is about to enter “driving season,” while diesel and gasoline stocks are near decade lows.

Long-term implications for crude oil hang in the balance as the European Union continues to discuss a ban on Russian oil. The EU’s proposal sets to ban crude oil over the next six months and refined fuels by early January. The EU’s decision process has been slow, because a few countries want exceptions. Hungary has been especially staunch in its opposition. Hungary has argued that banning, or phasing out, Russian oil would be too damaging to its own economy. The EU needs full support from its members to implement a cohesive ban on Russian crude.

AEGIS remains bullish on the forward curve. We believe risk skews to the upside the more you look into the future. Supply scarcity is a real concern, and the undersupply could push prices in 2H2022 and 2023 higher. However, this assumption relies on oil demand remaining strong. Many economists are concerned about a possible recession that could flatten the growth trajectory of demand.

Our hedging recommendations remain costless collars. A collar will allow producers to protect themselves against a severe recession scenario while allowing for upside. This reflects our view that the backwardated (downward sloping) oil curve is undervalued and a price appreciation in later tenors is more likely than not.

Natural gas futures are down this week; the prompt-month (June ’22) contract finished 41c lower. However, farther-dated tenors were less affected. The Winter ‘22/’23, and Summer ’23, Winter ‘23/’24 strips each decreased, but only by 34cc, 24cc, and 15c, respectively.

Production reached a year-to-date high last weekend but retreated to start the week. We are skeptical of daily changes in pipeline-based production models, but they are more useful in identifying trends. Pipeline nominations show lower-48 dry gas production is up by 0.8 Bcf/d week-over-week, are near pre-COVID highs, and could finally be headed higher. Baker Hughes data shows that gas-directed drilling rigs are up over 40% year-to-date, thanks to strength in the South Central region. U.S. lower-48 dry gas production is limited by takeaway capacity constraints; Appalachia has virtually no more room to grow (for now), but the Haynesville and Permian basins should support some growth.

LNG feedgas demand is down below 12 Bcf/d as facilities have been brought down for maintenance. Freeport LNG returned its capacity, only for trains at Cheniere’s Corpus Christi plant and Cameron LNG in Louisiana to go offline. However, the fluctuation in LNG feedgas demand is expected, as facilities usually bring trains offline for maintenance while demand is at its lowest for the year. Offsetting those reduced flows elsewhere, Venture Global’s Calcasieu Pass, the last facility that will be sanctioned until 2024, has managed to flow at fresh record-highs.

Optimism regarding U.S. LNG developments has been mounting. In a way, Russia’s invasion of Ukraine may have been the very best scenario for U.S. LNG. Most of the growth in global LNG demand was supposed to come from Asia, but now that growth may be a split between Asia and Europe as the latter tries to avoid Russian gas. As a result, LNG developers have been signing long-term offtake contracts and moving projects forward. For example, Venture Global has secured long-term offtake contracts for over 80% of the proposed 20 MM metric tons/yr Plaquemines LNG facility in Lousiana. Still, it has not reached a final investment decision (FID). However, it did not reach an FID with its previous facility until a similar share of the proposed capacity was booked in long-term offtake contracts.

AEGIS hedging recommendations continue to be costless collars for most clients. Call skew – when call options are relatively more expensive than comparable put options – has faded a bit but still provides ample upside participation without sacrificing much downside protection. This call-skew is even present in summer strips, with the Summer ’23 costless collar printing at around $4 x $5.82 versus a reference swap of $4.59 (late Friday). That’s an upside-downside ratio of around 2:1 which means that you are gaining over 2c of upside for every penny of downside.