Week Ending January 6

Demand concerns cloud a volatile oil market

Feb '23 WTI lost $6.49, or 8.1%, this week to settle at $73.77/Bbl. Concerns of an economic slowdown and China's demand woes continue to pressure oil prices.

The oil market continues to struggle with low levels of participation, with open interest near multi-year lows. Cumulative open interest for WTI and Brent is at its lowest since 2015. Open interest is the total number of outstanding futures contracts. It is important because the relationship between open interest and volume traded can significantly impact volatility. Low volume means less liquidity. Declining open interest means traders are closing pre-existing positions. Both create the possibility of larger bid-ask spreads and larger moves in prices.

In addition, net positions by "managed money participants" are at their lowest level since April 2020; think of these as CTA's and hedge funds, as opposed to the advisor type of CTA like AEGIS. Since 2021, the whole CTA trader group has reduced its outright positioning. Often, these traders follow trends, meaning they sell when prices are falling and buy when prices are rising. With the recent sell-off, there was an exodus of long positions by the group, exacerbating the fall in price. This is important because managed-money participants (speculators) perform a vital role in the market, enhancing overall market liquidity. Therefore, a healthy spec-trading community benefits those looking to hedge. The low net positioning reported by the CFTC corroborates the theory that there is a shortage of buyers to help support prices, hence the negative price response.

Looking now to fundamentals, global oil demand is expected to grow anywhere from 1.0 - 1.7 MMBbl/d in 2023, and China's demand growth accounts for nearly half of that number (around 0.6 MMBbl/d). The surge in Covid-19 cases across China remains a concern for demand in the near term, but the outlook is more constructive in the medium to long term following the shift in China's Covid policy.

China's mobility figures indicate some optimism as the nation expects a significant uptick in travel over the Lunar New Year (January 21-27). Authorities estimate 2.1 billion passenger trips during the holiday, more than double the 1.05 billion trips made in 2022. But a Covid surge still poses a threat to the country, and it will be crucial to see how China reacts to the likely increase in virus cases that will accompany the reopening.

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. If prices have now shrunk close to your budget levels, then let’s instead talk about a mix of swaps and collars that will give you the precise amount of protection you need.

Gas prices fall for a fourth consecutive week amid mild weather and another potential Freeport LNG delay

Natural gas prices posted their fourth-consecutive weekly loss this week, with the prompt contract reaching a one-year low. Four weeks ago, the prompt-month Henry Hub contract traded as high as $7.10/MMBtu; this week, it traded as low as $3.52/MMBtu.

While December was significantly colder than the 10-year normal and even experienced an extraordinarily severe winter storm during the week of Christmas, January is forecast to be the warmest since 2000, according to data from Commodity Weather Group. In fact, this was the warmest week since early November.

January weather holds more influence in the gas market because it is the time of year when gas demand peaks. Yet, the forecasted warmer temperatures and resulting lower demand will likely lead to smaller-than-average withdrawals from storage. A reduced need for these winter stores has caused the winter risk premium to disappear and led market participants to shift their view to the rest of 2023, which looks to be a well-supplied year.

More disappointments from Freeport LNG also likely subdued gas prices. Market participants have been waiting for the return of the 2-Bcf/d Freeport LNG facility since August. The export facility has already adjusted its restart schedule several times. This week, a new report from consulting firm Rapidan Energy suggested that the restart may still be months away. The report cites new requirements by federal regulators, that require Freeport LNG personnel to undergo new safety training following the root-cause analysis report. Freeport LNG did not announce a new schedule; it continues to guide toward a restart in the second half of January.

AEGIS Hedging recommendations for natural gas are more nuanced than we have guided in the last few months, given the steep price decline in recent weeks. Most upstream clients will now likely prefer swaps due to the added level of protection offered and our bearish outlook on gas for 2023 and 2024. However, some may still prefer costless collars to take advantage of a higher ceiling than a swap would provide. Reach out to AEGIS strategists for a conversation about what option is better for you.