Week Ending August 12

WTI fell on Friday but posted a weekly gain of $3.08 to finish at $92.09/Bbl as traders weighed the possibility of increased demand this winter against the potential for extra supply from Iran.

The 16-month-long Iran nuclear deal negotiations came to an end on Monday, and the EU has presented a "final" text for the United States and Iran to consider. A response is expected next week; if the U.S. and Iran can agree to revive the deal, oil sanctions relief as part of the deal could return as much as 1 MMBbl/d to a tight global market that has few options for near-term incremental supply.

Some major forecasters disagree in the near-term oil demand. In its August monthly report, the IEA increased its forecasts for global crude demand growth in 2022 by 0.380 MMBbl/d to 2.1 MMBbl/d (up from 1.7 MMBbl/d). Global oil demand is expected to reach 99.7 MMBbl/d in 2022 (up from July's estimate of 99.2 MMBbl/d). In addition, the group projects an increase in global stockpiles of 900 MBbl/d through year's end, citing numerous emergency SPR releases along with more resilient Russian crude production.

They added that even though Russian output has recently experienced a robust rebound, it anticipates that close to 2 MMBbl/d will be shut in by the beginning of 2023 as the EU embargo takes effect.

In contrast to the IEA's view, OPEC's tone was more pessimistic. In its August monthly outlook, the group now forecasts that the global oil market will be in a surplus this quarter.

OPEC reduced its forecast for global oil demand this year by 0.260 MMBbl/d to 100.03 MMBbl/d. It also cut its demand forecast for 2023 by the same amount to 102.72 MMBbl/d, implying that the demand growth rate in 2023 is unchanged, but that near-term demand will disappoint. This means that in 2023, demand would still grow by 2.7 MMBbl/d. Because OPEC expects supply from non-OPEC countries to rise by 1.71 MMBbl/d, OPEC would need to pump around 0.900 MMBbl/d more to balance the market. However, many analysts are skeptical about how much “real” spare capacity OPEC has.

The bloc does not expect an acceleration in U.S. shale production. The supply of U.S. tight oil is forecasted to increase by 0.800 MMBbl/d in 2023, up modestly from a 0.740 MMBbl/d increase in 2022.

Both these groups have demand rising by more than 2 MMBbl/d in 2023. In our view, inadequate supply is more likely than a meltdown in demand. Plan for the upside, while protecting against demand surprises. AEGIS hedging recommendations remain costless collars. A collar sets a price floor but also preserves some upside participation if prices move moderately higher than the forward curve.

Gas futures are on track to finish higher again. As hedge advisors, our fiduciary role sometimes requires us to take the contrarian view and note the risks despite prevailing sentiment. Gas prices have doubled since the beginning of the year and are at their highest levels in over fourteen years, AND IT’S SUMMER, NOT WINTER.

One reason for the higher price is that there has been an international shortage of natural gas. As a result, the U.S. has been sending as much gas as possible overseas to replace Russia’s role as the primary gas supplier to Europe. The global gas shortage has also benefitted the U.S. industrial sector as the U.S. is the lowest cost source of gas supply in the world, pushing industrial demand 1 Bcf/d higher year-over-year.

Another reason? Analysts overestimated the gas-to-coal switching capacity. Gas demand from power generation has hardly been affected by the massive price run-up. Further, scorching weather has pushed total generation much higher, as Americans require electricity to keep cool. Mix the demand with sporadically underperforming renewables, and you have a bullish recipe for summer gas prices.

We are very cautious about 2023 and 2024 and continue to warn against rising production. LNG exports have accounted for most of the demand growth in the U.S. over the last several years, but we are now in a lull until Qatar Petroleum’s and ExxonMobil’s Golden Pass export facility comes online in 2024. This is problematic because that means that, for the most part, every new molecule of production until then will contribute to a looser supply-demand balance. 

We recommend costless collars to most clients because of the extra value provided by the structure. Option skew in the natural gas market has favored call options, so the premium you receive from selling the call to complete the costless collar is worth more than usual. A Summer ’23 costless collar is printing at around $5.00 x $5.30, vs. a reference swap of $5.114. This type of “narrow” collar keeps your hedged volumes in a tight price range. If you can secure a $5 floor, get 18.6c (vs. ref. swap) of upside, and only sacrifice 11.4c (vs. ref. swap) of downside, why wouldn’t you? To us, wider collars make more sense during winter, where the chances of a supply scarcity event or market squeeze are more probable. However, we ask you to consider securing a higher floor in the summers, where the downside risks in 2023 and 2024 make that greater protection much more attractive.