Week Ending October 21

Oil posted a marginal gain after a volatile week. December ’22 WTI gained 40c this week, finishing at $85.05/Bbl as the market remains under pressure from uncertain Chinese demand and additional SPR releases.

On the supply side, the Biden administration announced their plan to release 15 MMBbl of crude from the SPR and may consider additional releases this winter in an effort to fight high fuel prices. The barrels are expected to reach the market in December. This latest release will be part of the final tranche of released crude from the 180-MMBbl program that started in May. At some point, they’ll have to fill it back up.

The White House also announced new details on its plan to replenish the SPR, which has been drained to just 405.1 MMBbl out of a total capacity of 714 MMBbl as of last Friday. The White House plans to initiate purchases when WTI is at or below $67-$72/Bbl. In our latest Afterparty event, we sought to explain the market importance and hedging implications of this plan.

Additional releases from the SPR, which most analysts believe have a high chance of materializing, still might not address all the underlying issues. The refined products market is facing refining capacity constraints, high demand ahead of winter, and record-low seasonal inventories. Refinery closures and conversions have cut U.S. refining capacity by nearly 1.1 MMBbl/d since 2020. By our count, there is one expansion of 0.25 MMBbl/d planned for next year, but there are no plans to build new refineries in the U.S.

The Biden administration is also mulling curbs on fuel exports to keep more gasoline and diesel in the country. However, oil-industry representatives and some analysts have warned that limiting fuel exports may result in higher costs in some areas of the U.S., particularly in the import-reliant Northeast.

On the demand side, China, the largest oil importer in the world, is still facing uncertain crude demand. Chinese President Xi said on Sunday that the government would maintain a strict Covid-zero policy, but it is reported that officials are considering reducing the required quarantine period for travelers. Despite the contradiction, China implemented further lockdowns on Thursday due to a spike in new Covid cases in certain areas of Beijing and other major manufacturing hubs.

China’s strict COVID curbs this year have adversely impacted business and economic activity and, lowered demand for fuel.

In the months ahead, the market will continue to face supply uncertainty as OPEC+ cuts output and the EU imposes sanctions on Russian crude. 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.

The November Henry Hub contract fell $1.49 to settle at $4.96 this week. Natural gas prices declined very quickly this week, making new six-month lows. The Summer ’23 strip fell $.61 to close at $4.53, and the Winter ‘23/’24 strip settled lower by $.47 to $5.21.

Part of the story has been the rapid rise in gas inventories since early September. This week’s EIA storage report showed a fifth-consecutive 100+ Bcf injection. These large builds have loosened the supply-demand balance considerably and reduced the storage deficit to a level that mostly removes the threat of a supply shortage this winter. Over the past five weeks, the deficit has narrowed from -354 Bcf to -183 Bcf; last week’s build, by itself, shrunk the deficit by 38 Bcf. These five most recent storage builds have been not only large on an absolute basis but also relative to history, with all of them printing outside of the five-year range of injections.

While this week's colder-than-normal weather led to a short-term increase in gas demand, the effect was overshadowed by bearish forecasts for the next two weeks. Weather forecasts for the next 15 days show what could be one of the warmest October-November periods on record, indicating temperatures that are several degrees warmer than 10-year normal weather. This weather is expected to affect the Midwest and Northeast regions, which are generally among the larger sources of gas demand for this time of year. As the forecast models have changed throughout the week, they have shifted to be warmer and, therefore, more bearish for gas prices.

AEGIS continues to recommend hedging via costless collars. Despite the large selloff in gas prices, call skew remains elevated. This call skew allows producers to implement hedges with a higher floor price and a higher ceiling (compared to what a neutral-skew market would offer).