Week Ending February 17

Crude weakens, but could there be upside ahead?

Oil posted a modest loss this week. The March ’23 WTI contract lost $3.38 on the week to finish at $76.34/Bbl. However, the bulls remain optimistic; there may be a recovery in Chinese demand in addition to supply risks from Russia.

The IEA and OPEC raised their global demand forecast for this year. Both organizations cited China’s reopening as their primary reason for doing so. The IEA sees China’s oil demand growing by 0.9 MMBbl/d this year, accounting for nearly half of the global demand growth (2 MMBbl/d).

Many analysts’ bullish views require Russian production to fall in 2023, but there is little evidence it’s happening yet, and prices have been range-bound around $77/Bbl since November. However, the risk of losing 0.5-1.0 MMBbl/d of Russian supply continues to persist. Russia’s resilience to Western sanctions may, at best, keep price neutral in 2023 if Russian crude exports remain steady.

Also, US Inflation data and remarks from Fed officials have exacerbated concerns about further aggressive rate hikes, which could both weaken oil demand by inhibiting economic growth and raise the value of the dollar.

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. The most likely of the bullish outcomes would be only moderate undersupply in 2023. Yet, there is still a problem with low inventories of oil and products as well as low OPEC spare capacity. This could provide slight scarcity and more leverage on price than it usually has.

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.

Gas loses 23.90c, or 9.5%, to the lowest since September 2020 as milder winter weighs on demand.

Natural gas prices resumed their multi-month downtrend this week, with the prompt month Henry Hub contract falling another 24c to $2.275/MMBtu. The natural gas price is the lowest since September 2020. Prices across the curve have also declined, with the Summer ’23 strip falling 30c to $2.743/MMBtu and the Winter ‘23/’24 strip losing 20c to trade $3.741/MMBtu.

While the Summer ’23 strip has deteriorated significantly over the last few months, falling from $3.86/MMBtu at the beginning of the year, the Winter ‘23/’24 strip has not experienced as much selling pressure. This is evidenced by the record-high prompt winter-summer spread of $1.004/MMBtu.

We believe the winter strip is overvalued and is likely to settle much lower, especially given the weak underlying fundamentals this year, likely making this a good time to de-risk next winter.

Meanwhile, Summer ’23 Waha basis prices are at their highest in over a year at -1.027/MMBtu. The $1.98/MMBtu rally in Waha basis over the past two months has correlated very closely with Henry Hub’s price deterioration. Looking ahead, crude economics dictate activity and growth plans in the Permian and is likely to keep gas output growth steady. Further, takeaway capacity is on track to expand by around 1.6 Bcf/d over the next 12 months, roughly in line with gas production growth expectations. However, Waha has demonstrated that it can trade at below-zero prices when egress capacity is tested, making the balance between these two factors paramount.

AEGIS hedging recommendations for natural gas remain swaps in the summer months and collars in the winter. Swaps provide more protection than collars but will cap any potential upside. However, a collar can be attractive for clients who want to participate in higher prices, especially with the overwhelming call skew present during the winter tenors.