Week Ending October 14

Oil posted a weekly loss as fears of economic recession and weak Chinese demand cast a shadow on the market. WTI fell nearly 8%, or $7.03, to end the week at $86/Bbl, reversing some of last week's gains that came after the OPEC+ alliance announced it would cut its cumulative production by 2 MMBbl/d. Crude was under pressure this week as hotter-than-expected Inflation data weighed on the market, while China’s COVID-zero policy subdued oil demand in the largest importing nation.

U.S. Inflation rose to a 40-year high last month. The core consumer price index—which does not include food and energy—rose 6.6% from 2021, reaching its highest level since 1982. The overall CPI rose 0.4% month-over-month in September after two flat months and was up 8.2% from a year ago. Analysts expected high inflation, but not this high. U.S. inflation data increases the risk of both higher interest rates and slower consumption, which would, in turn, threaten the outlook for economic growth.

China, the world's largest crude oil importer, reported more bearish economic data amid continued COVID-zero policies. Although the nation has fewer cases compared to other countries, it is much more aggressive in shutting down personal mobility when case counts rise. This policy is negatively impacting economic growth and, in turn, oil demand. Air and road travel during the first week of October's week-long holiday was down 42% and 30%, respectively, from the same period last year, according to Chinese government data. The lack of activity puts downward pressure on global oil prices as transportation makes up over half of China's oil consumption.

The IEA, in its monthly report for October, reduced its 2023 demand-growth forecast by 0.47 MMBbl/d to 1.7 MMBbl/d due to "stronger economic headwinds" from inflation and rising interest rates. The organization has warned that the move by OPEC+ to reduce oil supply raises the possibility that rising energy costs could act as the " tipping point for a global economy already on the brink of a recession."

Perhaps mitigating the concerns on the demand-side, we believe the supply-side remains constrained. OPEC’s new production cuts, an upcoming end of US SPR releases, and a ban on Russian crude all may coincide this winter. 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 while participating in some of the price recovery, should it happen.

Natural gas price action was relatively muted this week. The Henry Hub November contract settled lower by $0.26 to $6.49, Summer ’23 closed down $0.01 to $5.14, and Winter ‘23/’24 ended the week up $0.18 at $5.68.

There have now been four weekly storage builds above 100 Bcf. This streak of consecutive 100+ builds is a tie for the seventh-longest in natural-gas history.  This trend is a warning sign the supply-demand balance may be loosening more than usual in this autumn season, ahead of winter. Further, this streak of large injections has steadily shrunk the difference to the five-year average storage level. Inventories now are only 126 Bcf below last year’s early-October level. In just five weeks, the storage deficit to the five-year average stocks shrunk from-354 Bcf on September 9 to last week’s level of -221 Bcf. Last week alone shrunk the shortage by 43 Bcf. The current rate of storage builds should calm fears of low inventory levels; however, the ultimate arbiter of winter prices will, of course, be the weather.

Cooler weather is starting to show up in forecasts; space-heating demand is on the way. October is a key month in the gas demand transition because normal temperatures decline from about 65°F to start the month to just below 60°F by the end of the month. That range is quite mild, so it generates little gas demand. However, any slip warmer or colder, and October can generate a surprising amount of bonus demand.

This upcoming week will likely be one of those periods with the average temperature in the continental US forecast to decline to about 55 F, about 7 degrees cooler than the 10-year normal weather. The cooler weather will affect some regions more than others, though; the Midwest and Northeast are expected to average as low as 40-50°F. The South-Central and Rockies regions, however, may not generate any HDDs at all.

AEGIS continues to recommend clients hedge natural gas exposure using costless collars. Call-option prices remain elevated relative to put options, giving producers looking to hedge an opportunity to extract additional value from the market. This phenomenon is not as pronounced as it was earlier this year. Still, the elevated call skew can provide the opportunity to create a hedging structure with more protection on the downside (higher floor than usual), and more potential on the upside (higher cap/ceiling than usual).