The WTI prompt-spread flips into contango for the first time since March 2021. Could this be short-lived?
The second WTI contract (Jan ’23) is trading at a 15c premium to the prompt-month WTI contract (Dec ’22) for the first time since March. This phenomenon commonly referred to as "contango," is a characteristic signal of a loosening supply-demand balance. In theory, the 15c spread should incentivize more oil to go into storage. However, it could be interpreted as an indicator of weakness in the physical market or just a temporary trading aberration.
Oil posted a second-consecutive weekly loss. The December '22 WTI future lost $8.88, or 9.98%, this week, finishing at $80.08/Bbl. Prices rallied to nearly $89/Bbl mid-week on an uptick in geopolitical tensions before finishing at a six-week low. A series of headlines heightened market volatility. Reports of a Russian missile attack on Ukraine on Tuesday drove up prices. Prices then declined after NATO allies reported it was not a Russian missile. It was a stray rocket fired by Ukraine to defend their territory.
Also on Tuesday, as Russia advanced its attacks in Ukraine, the conflict caused damage to the Druzhba pipeline, a key oil pipeline that transports Russian crude to eastern Europe. Flows were resumed on Wednesday.
Immediate escalation in the Russia-Ukraine conflict might have tentatively eased, but the geopolitical risk persists as the market closely monitors the situation.
The IEA and OPEC both released their monthly oil reports and cut their demand outlooks for 2023. OPEC reduced its annual demand-growth forecast by 0.1 MMBbl/d to 2.4 MMBbl/d, while IEA said that demand growth would decrease in 2023 to 1.6 MMBbl/d from 2.1 MMBbl/d this year. Both organizations cited economic challenges and China's strict zero-Covid policy as the primary factors for their revision. Despite China announcing changes to its zero-Covid policy last week, Chinese state media and officials have said that the changes were a refinement of rules and not a relaxation of controls, indicating further demand uncertainty.
There is still an upside to crude prices and the forward curve, in our view, as the EU embargo on Russian oil looms and OPEC+ reduces output. EU's sanctions and the G7 nations' price cap will begin on December 5, and the G7 group expects to announce the price cap level next week. The sanctions could risk an estimated 0.5 to 1.5 MMBbl/d of Russian oil production, as the country has stated it will not sell its crude at unprofitable levels.
AEGIS Hedging recommendations for crude oil remain costless collars. A collar structure creates a price floor using a bought put option, but it sacrifices access to much higher prices. There is usually no cash outlay. Because this structure enables you to participate in a moderately higher-priced environment, costless collars are a popular way to hedge for protection in a market that you believe has more upside risk than downside risk. However, it is worth mentioning that the oil market is usually in put skew, meaning that the put options are worth more than the call options, so you don't receive as much value for your sold call option.