Week Ending October 7

OPEC+ alliance's decision to cut its cumulative production by 2 MMBbl/d led oil to a weekly gain of $13.15, or 17%, to settle at $92.64/Bbl. It was the largest weekly gain since early March. Russia also threatened to further cut its own production as a retaliation against the EU and G7 for a price cap on Russian oil.

This week’s news halted a downward price trend. Central bank rate hikes and concerns about an economic slowdown had pushed oil lower. OPEC+ and Russia have now increased the possibility of additional inflationary pressures.

The OPEC+ (OPEC plus collaborating countries) “cut” announced on October 5 was a reduction of their production quotas of 2 MMBbl/d, or roughly 2% of global consumption, in an effort to stop the decline in oil prices. Saudi Energy Minister Prince Abdulaziz Bin Salman said that unless the market changes, the supply curbs will be in place through December 2023.

AEGIS notes that even if the quota target is reduced, the actual production loss may be much smaller.  Many OPEC+ members, including Russia, are vastly underproducing compared to their quotas already. The shared pro-rata decrease among members would only require eight countries to reduce actual output, resulting in a real reduction of around 1.0 to 1.1 MMBbl/d.

The cuts would come just as the U.S.'s 1 MMBbl/d Strategic Petroleum Reserve releases come to an end. The U.S. oil-supply releases are currently scheduled to end in November (refilling begins in FY 2023). The timing could exacerbate a tight market this winter if global oil demand holds up.

Supply-side shortages may worsen as EU sanctions against Russian oil sales tighten in December. Russia reiterated this week that it wouldn't sell oil to countries that adopt the U.S.- led G7 price cap, adding to supply uncertainty.

All three supply-side issues – Russia's production risk, OPEC's new cuts, and the SPR – coincide in November. Hence, we believe there is an upside to prices and the forward curve. We still recommend costless collars for most clients.

A collar would set a price floor but with a cap on upside participation if prices realize much higher than the forward curve. Costless collars are a popular way to hedge for protection and also participate in some of the price recovery, should it happen.

Despite the third-largest storage increase in history, the prompt-month natural gas contract (November 2022) finished the week up 8c to end at $6.84, breaking a streak of five consecutive lower weekly closes. Summer ’23 followed in a similar fashion, gaining a meager 7c and closing at $4.96.

The past three storage builds have consistently come in above median analyst expectations and above the five-year average range for this time of year. But this week’s build was huge: at 129 Bcf, it was not only the largest storage build of 2022, but it was the largest ever for any September. Earlier this year, there was a substantial gas-storage deficit, but no more. These above-average storage injections have reduced the deficit to the five-year average to only 264 Bcf, and our models suggest winter could start with 3,510 Bcf in storage, a comfortable number.

That large build is likely anomalous. The effects of Hurricane Ian contributed to the size of this build; the storm knocked out power-generation demand and provided cloud cover to a large gas-demand region. While the storage report may have seemed bearish, the market did not react as if it was. Prompt-month Henry Hub futures rose almost 3% in the 15 minutes immediately following the report.

Summer is behind us, so the gas market is changing. As the weather cools across the Lower 48, the amount of demand from electric-power generation begins to decline, while demand from residential and commercial heating begins to rise. For example, some cooler weather, mostly in the Northeast, may have boosted space-heating demand by over 4 Bcf/d this week. Meanwhile, demand from the power sector was near a 6 Bcf/d loss, wiping out the residential-commercial gains. As winter approaches, heating demand will matter more, estimates of demand will get less precise, and the error in forecasting weekly storage numbers will increase.

AEGIS hedging recommendations continue to be costless collars for most clients. Why? Call skew in the options market is still elevated. This aberration can provide added value for producers (but not consumers!) looking to hedge because they can sell a relatively expensive call option to subsidize the purchase of a comparatively inexpensive put option. We offer this recommendation in both crude oil and natural gas, although the amount of call skew is higher in the gas market.