Week Ending December 30

Can oil rebound in 2023?

Despite record-breaking volatility in 2022, WTI is on track to post a yearly gain of just $5.05/Bbl, or 7%. It’s a small yearly gain after rising 55% in 2021. Brent will finish 2022 up $8.13/Bbl, or 10.45% higher, after rising 50% in 2021. Additionally, Feb ’23 WTI (the prompt month) gained 70c on the week to settle at $80.26. 

On the supply side, Russian exports may have defied expectations throughout 2022, but that’s because the most serious sanctions are just now taking effect. One of those sanctions is a coordinated price cap by the G7 countries. In response to the G7 price cap, Russia recently announced a ban on oil and oil product sales to countries that comply with sanctions, beginning on February 1, and lasting through July 1, 2023.

Russia’s flagship crude is already trading below the $60/Bbl cap set by the G7 nations, meaning most trade can continue regardless of the restriction. Still, analysts expect Russian production to fall by 1.0-1.5 MMBbl/d in 2023, compared to 2022, due to the price cap and sanctions.

On the demand side, China is seeing a surge in Covid cases after abandoning its Covid-zero policy that was in place for more than two years. AEGIS notes that despite the rise in new cases, oil demand could see a significant increase in the world’s largest oil importer after the initial Covid wave subsides. Demand there may also be more consistent. IEA forecasts China’s oil demand to grow by 1 MMBbl/d in 2023. However, concerns about whether the country can sustain its eased restrictions persist as Covid infections surge.

AEGIS believes price risk is skewed to the upside in 2023 as the risk of supply shortfalls outweighs demand risks. Therefore, AEGIS hedging recommendations for crude oil remain costless collars for 2023 and 2024. A collar would set a price floor but allow for more upside participation, compared to a swap, if prices realize higher. The upside exposure afforded by the structure makes it very popular among our clients in bullish markets.

Despite some bullish data, natural gas finished the week at its lowest level in over six months.

Production freeze-offs and the largest storage withdrawal of the season failed to keep gas from moving lower. Freezing temperatures last weekend had forced producers to temporarily shut-in over 16 Bcf/d of production, but it has since recovered back to 97 Bcf/d, according to PointLogic data

The EIA reported the largest withdrawal of the winter season so far, coming in at -213 Bcf, 108 Bcf larger than the five-year-average withdrawal for the corresponding week. Not only was the withdrawal massive, but it was also 14 Bcf larger than the Bloomberg survey estimate of a -198 Bcf pull on inventories.

While a substantial drop in production and a large storage withdrawal would generally be considered supportive of gas prices, prices continued their multi-week retreat. The prompt-month NYMEX contract fell below $4.50/MMBtu.

A possible explanation for this is that the market may be more focused on the weather forecasts for early-mid January as it is considered a “peak-demand” month and usually boasts the largest risk premium. However, current forecasts show temperatures will stay above average through at least mid-January, keeping demand relatively low. This abnormally low demand will likely result in smaller draws on storage, lessening the likelihood of any supply-scarcity event by winter’s end, leading the fear premium to fade from the market.

AEGIS Hedging recommendations continue to be costless collars for the winter tenors due to the high call skew exhibited in these months. We usually prefer swaps for summer because of option skew and our bearish outlook. Clients who value a higher floor over optionality may prefer swaps, even in winter.