Week Ending July 1

WTI August futures traded in a $9 range this week, but ultimately arrived at $109.06/Bbl, near where it was last Friday.

The topics moving the oil market this week were familiar ones, but with some twists. Geopolitical tensions related to Russia-Ukraine, of course, continued. But Libya’s outages (around 0.7 MMBbl/d) and Ecuador’s force majeure related to fuel protests (0.2 MMBbl/d) added some bullish force to prices.

Meanwhile, economic worries keep a lid on prices as demand is uncertain. AEGIS notes that some industrial fuels (e.g. diesel) already seem to be showing weakness. Is it a temporary blip, or a leading indicator?

We still think that suppliers of crude are going to find difficulty meeting global demand growth in 2H2022 and 2023. OPEC’s production is struggling to meet quotas. Russia crude is being avoided by Western economies. U.S. investment is insufficient to return to a pre-2020 growth trajectory and supply the world.

Therefore, there is more upside risk to prices through 2023, in our view. How should producers hedge it? Use structures that protect against surprises, but only minimally restrict you to higher prices. The most cash-efficient way to do that is through costless collars (buy a put option, and sell a call option). For consumers of crude-linked products, such as diesel: note that the forward curve offers you a steeply discounted price, compared to spot. Swaps are a highly effective way to lock-in lower prices and control the fuel expense.

June was the worst month for natural gas prices since at least 2018. The cause of the selloff? The weather has moderated, and the U.S. supply-demand balance has been confirmed as looser for two consecutive weeks.

A month ago, the U.S. was on path to enter with winter inventories at around 3.3 Tcf, which would be around 400 Bcf below the five-year average and the second-lowest start to a winter in over a decade. Further, the market was undersupplied, and the storage deficit to the five-year average was expanding. We believed that this was leading to increased buying pressure in the market and consumers hedging to protect against the chances of a supply shortage this winter. Then came the destructive fire at the Freeport LNG export facility.

One way to solve an undersupplied market is through price: either prices cause consumers to conserve (and not buy) or cause producers to expand their output. The Freeport LNG outage essentially did all of the heavy lifting for prices and removed 2 Bcf/d of consumption, likely through the rest of the injection season. As a result, in our base case, we now have inventories at around 3.55 Tcf. The market would be much less likely to experience gas shortages with that level of gas in storage. Therefore, gas prices would warrant less of a “winter premium.”

Weather forecasts have softened a bit and have probably exacerbated the selloff. May was the hottest on record, and June was the second hottest. Now, July is forecast to be around its 30-year normal, which is not bearish by any means, but rather a break in the overwhelmingly bullish trend we have seen in weather so far this injection season. Still, any weather forecast beyond two weeks should be viewed with healthy skepticism as it can change quickly. For example, the June forecast was near its 30-year normal at the start of that month, but a late heat wave pushed the total degree-day count to its highest in at least the last twenty years.

Our hedging recommendations remain costless collars because of the call skew that is present in the options markets. No matter your opinion on future gas prices, collars can make sense because you would receive an unusually large premium for selling the “extrinsic value” – access to the highest-price scenarios.  Even tight collars (where the “floor” and “cap” price are not very far apart) make sense in that you can still capture the extra value inherent in the call options, but you also uplift your floor to a level high enough that it secures a large amount of revenue.