Week Ending June 10

West Texas Intermediate finished higher for the seventh consecutive week, settling on Friday at $120.67/Bbl. The surge in oil prices contrasts with the current onslaught in equity markets, fueled by concerns of a recession and high inflation. The S&P 500 has lost nearly 5% in the last week, while WTI has had a modest weekly gain of $1.8/Bbl.

U.S. consumer inflation hit 8.6% in May, the highest level in more than 40 years, pressuring the Federal Reserve to continue raising interest rates aggressively.

As the summer driving season started, the rising demand for motor fuels and low inventories signals a tight supply situation for oil and oil products. Oil product cracks, a barometer for refiner profitability, have risen as gasoline, and diesel prices have risen faster than crude prices. Retail gasoline and diesel prices hit a record high of $4.986/gal and $5.753/gal, respectively. There is fear that there is insufficient refining capacity in the United States and around the world to meet fuel demand. 

China is slowly relaxing most of its COVID restrictions, even as new temporary lockdowns are planned for parts of Shanghai. However, analysts predict a challenging road to recovery for oil demand if the lockdowns persist. Moreover, any quick demand recovery in the world's most populous country will put exacerbate an already-tightening market from disrupted Russian flows.

Our hedging recommendations remain costless collars. A collar will allow producers to protect themselves against a severe recession while allowing for upside. This reflects our view that the backwardated (downward sloping) oil curve is undervalued, and prices for the further-dated tenors skew to the upside.

Gas prices managed to finish higher this week, despite an explosion at Freeport LNG’s 2 Bcf/d facility. The July contract did flirt with the $10 mark intraweek before the news broke about Freeport, sending gas down over $1 in under an hour. The prompt contract finished Friday down around 1.26%, or 11.3c, to finish the week at $8.850. This contrasts with the Summer ’23 rally of 60c, or 11%, to $5.953, its highest level yet. This week, several strip prices reached their highest prints as some of the backwardation faded from the market.

The explosion dominated most of the headlines this week, but details have been sparse. So far, all we really know is that the facility will be down for a minimum of three weeks, per Freeport LNG. The facility has averaged around 2 Bcf/d of natural gas consumption, and now that gas needs somewhere to go, likely South-Central storage. Robust power demand in the region is forecast to offset some of the impact. Still, the outage shows how much sway these export facilities have on the U.S. market, as near-term gas futures plummeted in response to the news. If the outage persists for longer, then it could loosen the U.S. market and help lead to more elevated inventories going into winter.

AEGIS hedging recommendations remain costless collars for natural gas. There are two reasons why we are recommending collars for most clients. 1.) Call skew in the gas market makes the structure very attractive, with upside-to-downside ratios of 4:1 for some winter tenors and even 2:1 for summer ones. 2.) The heavy backwardation in this market may eventually normalize and see the further-dated tenors “roll forward” (the phenomenon where future prices move higher to converge with near-term prices). In this situation, the collar allows for a higher realized price because of the upside participation afforded by the structure.