Week Ending August 19

WTI rose on Friday but posted a weekly loss of $1.32 to finish at $90.77/Bbl as the market weighed the potential of OPEC's limited spare production capacity, developments in the Iran-U.S. nuclear talks, and a bullish EIA report.

U.S. crude oil exports set a new weekly record at 5 MMBbl/d for the week ending August 12. WTI (and Houston WTI) has been trading at more of a discount to Brent, making purchases of U.S. crude more appealing to foreign buyers. There are other export incentives, too. Russian crude flows may be rerouting from the European market, which now needs a replacement. The strong pace of crude exports was the main contributor to a huge 7.1 MMBbl draw on U.S. oil inventories last week. Some analysts were surprised, as the API estimate was a small 0.5 MMBbl draw.

At the same time, gasoline stocks fell 4.6 MMBbl, far above expectations, indicating strong demand.

On the supply side, the market is awaiting developments from negotiations to revive the 2015 nuclear agreement between Iran and the U.S. A negotiated deal would likely increase Iranian oil exports by removing oil sanctions. But a deal isn't looking likely. Officials from the EU and the U.S. are reviewing Iran's response to what they described as their "final" proposal to keep the deal alive. But Iran has insisted on U.S. guarantees that a new agreement would be permanent, essentially requiring it to have ratified-treaty status. Many expect this to kill the deal. However, if an agreement is reached, the nation may increase output by nearly 1 MMBbl/d, perhaps starting in phases beginning in 2023.

Meanwhile, OPEC's new Secretary General Haitham Al Ghais warned that a supply crunch through 2022 is likely due to increasing global demand and dwindling spare capacity. He was certain that the global oil demand would increase by roughly 3 MMBbl/d this year while spare production capacity was "becoming scarce."

AEGIS hedging recommendations remain costless collars. A collar would allow for a price floor to be set to protect against a price decline and also allow for upside participation if prices realize higher than the forward curve.

Gas prices finished higher again, but without any major bullish headlines. This week's storage report was very bullish. But other than that, it's been a pretty quiet week. What's more perplexing is that gas has been strengthening despite milder weather forecasts that implied decreasing demand.

As the summer heat starts to wind down, inventory levels for winter are more certain. We expect the end-of-season stocks (usually late-Oct or early-Nov, when inventories peak before the heating season) at 3.38 Tcf, but how does that stack up to prior years? A 3.38 Tcf start would be the second-lowest behind 2018; such a level should make any cold weather this winter have an outsized effect on price. On cold days, inventory is often the largest daily supply source during winter. If there are inadequate inventories, then the chances of a supply scarcity event are amplified.

The fear of scarcity is often amplified in the options market. Call options, which pay off big when prices rise, are a favored hedging vehicle for consumers. They are also speculators' favorites because they have built-in leverage with predefined risk. So when the market (consumer or speculator) expects some scarcity, the call options get bid higher. This is a useful situation for a producer hedging with costless collars (where you sell a call option to finance a put option; it caps your price but sets a floor). A comparatively more expensive call lets you set a higher floor. Some winter costless collars this week had upside-to-downside ratios of 3:1. Neutral would be 1:1.

Because of this "skew," our trade recommendations are still collars throughout the curve. The current call skew in the gas market, which is well above historical norms, makes the structure too attractive not to consider. It allows a hedger to maintain maximum upside potential in the event of a prolonged period of higher prices while still protecting cash flows with the floor price above levels required by most budgets.