Week Ending December 16

Crude’s recent weakness is inconsistent with the bullish risk to supply.

This week crude prices finished in positive territory despite the bearish headlines that dominated the news cycle. First, the Fed released its economic projections that showed inflation would remain elevated in 2023 and require further money-policy tightening, despite the recent data showing an easing CPI. Second, traders mulled the possibility of smaller disruptions to Russian supply than anticipated. Nevertheless, the prompt-month (Jan ‘23) WTI contract reversed some of last week’s losses, gaining $3.27 to finish the week at $74.29/Bbl.

Bloomberg reported this week that Russia is putting together a response to the EU-G7 price cap. Russia’s plan is expected to exclude a price floor. Instead, the executive order would forbid sales through any contract that refers to a price cap but would not ban specific nations from buying Russian oil.

The risk to the Russian oil supply is perceived to be less severe than previously thought. The possibility of only limited disruptions to Russian supply has weighed on prices in the near term, but analysts still expect Russian production to fall by 1.0-1.5 MMBbl/d in 2023 due to the price cap and sanctions.

Meanwhile, OPEC+ intends to maintain flat production through 2023. As a result, AEGIS believes that price risk is skewed to the upside; supply risks outweigh demand risks.

On the demand side, China's swift reversal of its Covid-zero policy has given rise to optimism for its long-term demand recovery. However, the near-term forecast is uncertain due to an increase in Covid cases.

Monetary policy is still influencing many asset-class valuations. The Federal Reserve raised interest rates by 50 basis points on Wednesday, reiterating that the U.S. inflation rate is still high and that further rate increases remain on the table. This hawkish tone by the Fed has also led to concerns regarding economic growth and, thereby, the impact on oil demand growth.

T.C. Energy is awaiting regulatory approval from PHMSA to restart its 622-MBbl/d Keystone oil pipeline. A pipeline segment not affected by its recent leak restarted on December 14. The shutdown is limiting deliveries of Canadian crude to the Gulf, where refineries process it or export, and the U.S. storage hub in Cushing, OK. The shutdown is not likely to have an immediate impact on retail fuel prices due to the relatively lower demand for gasoline in the winter. Still, it will probably affect some refiners' profits.

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.

Winter storm tracks across the U.S., but price spikes have been contained to the West Coast

Last week cooler weather caused cash prices in California and the Pacific Northwest to rally, but as winter weather moves across the Midwest and into the Northeast, those two regions’ gas prices have failed to react with the same vigor. The Malin hub in Oregon climbed to as high as $45/MMBtu last week, up from $15/MMBtu a week prior, while prices at hubs in the Midwest and Northeast are mostly unchanged.

One possible reason is that gas markets on the West Coast are more finely balanced, with little margin for error, compared to other parts of the country. An unexpected or unusual increase in demand sends the market into pronounced undersupply. Storage is of limited help; the EIA’s most recent data shows the Pacific gas region as the only region with storage significantly below the five-year range. Current Pacific region gas inventories stand at 203 Bcf, a 59 Bcf deficit to the five-year average. A structurally tight market combined with cold weather may have been enough to send prices soaring. At first, higher prices can attract more gas from other pipeline-connected regions. When that’s not enough, prices rise high enough to destroy demand.

Countrywide, the most-watched item for gas over these last few months has been the return of the 2-Bcf/d Freeport LNG facility in the Houston area. This week, the Federal Energy Regulatory Commission (FERC) asked Freeport LNG to respond to 64 questions related to the safety and operations of its LNG export plant. The new list of requests could delay the potential restart even further, though Freeport LNG has insisted that there have been no new changes to its outlined restart schedule of gradual increases through January.

AEGIS Hedging recommendations are costless collars for most tenors. However, we still like swaps for Summer 2023 because we believe that price risks are skewed to the downside. Swaps provide more certainty in that they effectively set a fixed price for any volumes hedged if done appropriately. Further, right now, options are not priced attractively for a producer in the summer. The lack of so-called “call skew” in the Summer ’23 strip means that call options are not relatively expensive, so there is not much premium to collect when you sell one as part of a costless collar. However, in 2024 we like costless collars more, even in the summer, as we believe the fundamentals imply a tighter market as the third-wave of LNG facilities starts to come online.