Week Ending December 2

Could OPEC+ reduce production just as Russia retaliates against EU sanctions?

Oil snapped a streak of three consecutive weekly losses. WTI posted a weekly gain of $3.70, finishing at $79.98/Bbl as the market continues to whipsaw on headlines. China backing away from its strict Covid-zero policy, speculation that OPEC+ plans to cut its production, the G7 oil-price cap, and the EU's sanctions on Russian crude drove prices this week.

China may be softening its Covid-zero stance, which has eased some demand concerns. Crude prices rallied at the start of the week as the Chinese government eased testing and lockdown requirements in several cities. The changes may allow China to fully reopen its economy.

There were also reports (rumors) of OPEC+ cutting production at the beginning of the week. However, those were unsubstantiated reports, and the market consensus is that the group will adhere to its current output level at Sunday's meeting. However, if OPEC+ does reduce production, it could be doubly bullish if it coincides with reduced Russian output after the EU's upcoming ban on Russian oil.

The European Union approved a price cap of $60/Bbl on Russian crude. The price cap will go into effect on December 5, along with sanctions on Russian crude. The sanctions could risk an estimated 0.5 to 1.5 MMBbl/d of Russian oil production. The cap aims to limit Russia's revenue while averting a supply risk. However, there are plans to allow regular evaluations and potential revisions of the price cap every two months starting in January 2023.

AEGIS expects the price cap to be more bullish than not for oil prices. A cap at any level would raise the possibility that Russian production will decline, thereby tightening the oil markets. The focus remains on how the Kremlin reacts to the price cap;  the country has said many times it will not sell to those who partake in the price-cap mechanism.

AEGIS hedging recommendations for crude oil remain costless collars as the risk in 2023 and 2024 is to the upside. 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. 

Freeport LNG outage is extended into year-end.

Prompt-month natural gas prices slid lower throughout the week, finishing 96c lower on Friday at $6.281. While changes to weather forecasts and storage levels led to volatility throughout the week, news on Friday from the heavily-watched Freeport LNG export facility likely weighed on prices.

On Friday morning, Freeport LNG delayed its expected restart date – again. The 2.1 Bcf/d export facility has been offline following a fire in June and has given multiple potential restart dates only to extend them each time. Their most recent timeline called for gas flows into the facility to ramp up in mid-December and reach full capacity by March. However, on Friday, Freeport extended this date another two weeks, bringing the expected restart date closer to the end of the year. The reason for the extension was regulatory procedures, a similar cause of the several previous extensions. Before Freeport can restart, it must submit several documents to federal regulators for approval. Once the export terminal restarts production, the gas market should tighten by about 2.1 Bcf/d.

According to our calculations, the market has been oversupplied by about 2 Bcf/d on a weather-adjusted basis for the past five weeks. The oversupply in the market is one of the main reasons gas inventories have built at such a rapid pace this fall, effectively erasing a hefty storage deficit that had existed through this summer. However, suppose the market balance returns to being balanced. In that case, combined with a forecasted cold December, storage levels could be much lower than average by the end of winter. The expectation of thinner inventories would support prices going into summer.

AEGIS Hedging recommendations for natural gas continue to be costless collars for clients who desire optionality and the ability to participate in the upside. We suggest swaps for clients who want the most certainty in their cash flows. The tiebreaker would go to how much “call skew” is present in the market. Your strategist can show you the current metrics.