Week Ending February 10

Oil posted a substantial gain this week. The March ’23 WTI contract gained $6.33 on the week to finish at $79.72/Bbl. The market remains optimistic about a recovery in Chinese demand in addition to supply risks from Russia.

EU-G7’s sanctions and price cap on Russian refined products came into effect on February 5. The group of countries agreed to cap the price of Russian oil products that trade at a premium to crude at $100/Bbl and products that trade at a discount to crude at $45/Bbl. In retaliation to the sanctions and price caps, Russia announced it would cut 0.5 MMbbl/d of oil output in March. Cynically, we think that Russia likely knows it has to reduce output in response to sanctions as finding outlets for its crude and product has become more cumbersome. In addition, the 0.5 MMBbl/d reduction could be a temporary measure.

Many analysts’ bullish views require Russian production to fall in 2023, but there is little corroborating data yet, and prices have been range-bound around $77/Bbl since November. Russia’s resilience to Western sanctions might become less bullish in 2023 if Russian crude exports remain steady.

Supply disruptions in Turkey and Norway lent supported crude prices this week. Turkey halted crude supplies to its Ceyhan export terminal on the Mediterranean coast following two earthquakes on February 5. The terminal exports about 0.65 MMBbl/d, and flows should resume late next week. In addition, the North Sea’s largest oil field also halted 0.5 MMBbl/d of output this week.

On the demand side, weak economic data from China weighed on prices. Also, Fed Chair Jerome Powell announced that more rate hikes are ahead, although data showing disinflation has begun.

AEGIS believes price risk is skewed to the upside in 2023 as the risk of supply shortfalls outweighs demand risks. However, some analysts are revising demand estimates lower and forecasting a looser oil market in 2023.

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.

Natural gas prices have recorded their first weekly gain in seven weeks, although not by much. The prompt month Henry Hub contract rose by 16c to $2.57, while seasonal strips also recovered. The Summer ’23 strip rose 18c to $2.57 and the Winter ‘23/’24 strip climbed 8c to $3.04. 

After consistently printing looser since September 2022, our weather-adjusted supply-demand model has shown a tighter balance over the last two weeks. This could be a head fake in market tightening as production has been subject to freeze-offs and other intermittent reductions.  However, it could be an indication that the power sector is using higher amounts of gas versus coal due to lower gas prices.  

We have been watching the power market for signs of increased gas burns or higher levels of coal-to-gas switching. While it is likely too early to come to a definitive answer, there are signs that natural gas may be stealing some share of the thermal load from coal. For example, coal generation has declined this week from about 120 GW last Friday to 70 GW, while power generation from natural gas held roughly constant week over week. But again, this could be a temporary blip; however, we will continue to monitor these dynamics. 

AEGIS recommends swaps in the summer and collars during winter, given the high call skew present in the winter months. However, the options market is exhibiting put skew for summer. Further, put skew in the prompt month is at an all-time high. The high level of put skew reflects the bearish overtone in the market at this time.