Week Ending November 11

Although China is committed to a so-called “Zero-Covid” stance, signs of a full reopening are in the works due to a subtly changed official policy. Oil markets remain apprehensive of Zero-Covid as it may determine demand-growth rates in 2023.

Despite a late recovery this week, oil reported another weekly loss. December '22 WTI lost $3.65, or 3.9%, this week, finishing at $88.96/Bbl. China's Zero-Covid policy was again in the news; any updates regarding China’s Covid-lockdown attitude have been adding to volatility in the oil market in recent weeks.

China announced that it’s planning to ease or adjust its strict Zero-Covid policy to minimize the impact on economic growth. A newly appointed committee announced that the nation would reduce the quarantine period for travelers and others who have been in close contact with infected people. China also plans to rescind penalties against airlines for bringing new virus cases into the nation.

Lockdowns have adversely impacted China’s fuel demand this year. Despite China’s extreme efforts, daily Covid cases have climbed to their highest since April. The recent announcement of loosening some Zero-Covid restrictions may eventually increase fuel consumption in the second-largest economy and tighten petroleum supply on a global scale.

China’s demand is crucial as it is the largest importer of crude, and its domestic demand significantly affects the global oil supply-demand balance. Demand has been particularly weak in recent weeks after the resurgence in new Covid cases.

The pace of reopening will be a key factor in deciding the demand outlook for 2023. Many analysts doubt a rapid reopening, but if China's Zero-Covid policies are broadly relaxed, it would be bullish for crude demand.

Additionally, a weaker dollar has been supporting prices this week. The dollar index, which compares the value of the U.S. Dollar to six other foreign currencies, fell nearly 4% this week to 106.4. Data revealed that the October U.S. CPI was lower than expected. Historically, the value of the U.S. dollar has been inversely correlated with the price of oil, so a weaker dollar (DXY Index) can cause foreign buyers of dollar-denominated commodities to pay less for the same amount of goods.

On the supply side, the risk of supply disruption due to sanctions on Russian crude continues to loom. EU’s sanctions and the G7 nations’ price cap are set to begin on December 5, and the supply and price consequences are still unknown. The sanctions could risk an estimated 1.0 to 1.5 MMBbl/d of Russian supply loss.

The market will continue to face supply and demand uncertainty in the months ahead as OPEC+ reduces output, the EU sanctions Russian crude, and China fully lifts Covid lockdowns. Hence, we believe there is an upside to prices and the forward curve.

AEGIS hedging recommendations for crude oil remain costless collars. 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 price recovery, should one happen. 

Wild, not-confirmed rumors about Freeport LNG’s return (or not?) to service jerked gas prices down on Friday. Weather also continued to drive record volatility in gas prices, despite the deficit to the five-year average inventory level nearly being erased.  

Prices had been recovering through the latter half of the week before plummeting over 10% intraday on Friday after rumors relating to the restart of the Freeport LNG export plant surfaced. The first rumor alleged that Freeport would be unable to restart until December at the earliest due to damaged pipes at the facility. Then, another supposed – but fabricated – statement from Freeport came out denying the previous report. Freeport later released an official statement on their website denying any new updates on the restart of the facility.

Once Freeport restarts, there should be less confusion in the market, but volatility around weather model runs will remain, especially once gas starts to be withdrawn from storage. Colder weather forecast changes over the weekend made gas prices jump higher on Monday.  Yet, three days later, prices had fallen back below Friday’s settlement. It was puzzling because forecasts only turned slightly warmer.

Gas prices in 2022 have exhibited more volatility than any other year of the last 20 years. This volatility is visible in both price moves and in implied volatility in the options market.  

With winter weather approaching, could the volatility continue? While gas inventories have nearly closed the gap to the five-year average storage level (now at -76Bcf), a colder-than-normal winter threatens to leave inventories at a low level once again. By our calculations, a winter season with just 5% more heating degree days than normal could send inventories to near the five-year low.

On the other end of the spectrum, a winter that is 5% milder than normal could leave gas storage significantly above the five-year average, closer to the top of the range. A glut of gas remaining in inventory to start April could require gas prices to drop low enough to create 2 Bcf/d of power demand next summer.  

These statements may seem obvious and trite, but here is our point: the random path of weather this winter could influence the supply-demand balance not just for the next few months but into 2024. You can’t predict it, but you can hedge it.

AEGIS hedging recommendations are dependent on the tenor in which a client wants to hedge. For the summer seasonal strips, swaps are the default choice, while in the winter strips, costless collars can still provide a benefit because of elevated call-option premia. This decision will depend on the needs of the client and whether they want more optionality or more protection.