Week Ending June 3

Oil posted a sixth weekly gain after an OPEC+ meeting yielded only a minor boost in output, failing to ease tensions about an increasing supply deficit.

West Texas Intermediate finished higher at $118.87/Bbl on Friday, with a nearly 3% weekly rise. The OPEC+ cartel agreed to 648 MBbl/d output increases in July and August, advancing their production targets for the year, despite some members struggling to achieve quotas. The hike amounts to just 0.4% of global demand.

Prices have been surging in the past week as the EU agreed to ban Russian oil, Chinese lockdowns were lifted, and the summer driving season is underway.

The EU will stop importing all Russian crude oil transported by sea, which accounts for around two-thirds of all Russian crude imports. The oil phase-out starts in December, and Russian oil products, two months later. It is unclear how much of the orphaned Russian crude Asian countries could absorb. Ironically, extra waterborne supply could become available, but with fewer buyers; other, replacement crude sources would be bid up and prices could rise.

Additionally, China eased its strict COVID-19 restrictions this week. As the country emerges from a prolonged period of lockdowns, its oil demand is expected to rise, putting extra strain on a market that has already tightened dramatically since Russia invaded Ukraine. Analysts at FGE estimate Chinese oil demand to rise by as much as 600 MBbls/d this month, increasing another 400 MBbl/d in the second half of the year.

AEGIS hedging recommendations remain costless collars for those looking to add volumes. Our view remains that the forward curve is undervalued and has more risk to the upside. The market is rightly concerned about supply scarcity.

Natural gas for July finished Friday at $8.52 MMBtu, some 50c lower than the $8.99 settlement last Wednesday – when it reached its highest in more than a decade. Gas demand remains robust in the power sector thanks to short supplies of coal and high global coal prices. LNG exports are also near the maximum. Supply has crept higher, but production is still under where many analysts thought it would be.

There are only about 160 days left before gas injection season ends (Nov. 11) and withdrawals for winter begin. Despite some recent weakness in the daily gas supply-demand balance, weather-adjusted measures of the market show a balanced or slightly undersupplied market relative to the five-year average. What does this mean if this balance holds? It means natural gas in storage will start withdrawal season with about 3.3 Tcf in the ground. That would be the second-lowest starting winter inventory level in at least the past 10 years. Even if stocks could balloon by another 275 Bcf over 3.3 Tcf by November, inventories would be the second-lowest for a start to winter, in the last decade.

Why do we point this out? The market is more susceptible to upward price pressure this winter. If winter turns cold, there would be supply worries. This is not our base case but it’s worth pointing out the risk, especially to our consumer clients worried about further price rallies.

AEGIS hedging recommendations for producers remain collars for all tenors as the upside call-skew is too great to overlook. We also have discussed with producers about buying put options. For example, the Summer 2023 swap is at $5.34 and a $4.50 put cost about 52c. Buying puts for the gas market is not as common, but with the parabolic rally in prices, it allows producers to secure a net floor near $4.00 while leaving all the upside, should prices rally. To discuss in more depth optionally around hedging with puts, please reach out to the trading desk.

A consumer worried about further price rallies this winter should consider a swap as a way to protect risk and avoid expensive call options. The consumer should also consider whether 2023-2024 prices are attractive for hedging, because they are trading at much lower prices than are 2022.