Week Ending February 24

Oil bulls optimistic despite macroeconomic woes

Oil posted a marginal weekly decline. The April ’23 contract lost $0.02 on the week to finish at $76.32/Bbl. Bulls can remain optimistic, though; there may be a recovery in Chinese demand and supply risks from Russia.

China’s demand is showing a swift recovery. Evidence includes mobility data that shows more travel and increased imports of Russian oil. However, industrial activity still lags, keeping a lid on demand’s potential.

Despite little evidence of Russia losing any supply after the EU-G7 price caps and sanctions, reports of its “shadow fleet” of oil tankers struggling to find new buyers could imply a risk of curtailing 0.5-1.0 MMBbl/d of supply this year. Russia remains a bullish flag; AEGIS believes that Russia’s resilience to Western sanctions may keep prices neutral in 2023 if Russian crude exports remain steady. More supply shortfalls from Russia would be a bullish factor not currently incorporated into the price.

Minutes from the recent U.S. Federal Reserve meeting showed that the majority of Fed officials agreed that the risks of high inflation warranted further rate hikes. Fed’s recent hawkish tone also led to concerns regarding economic growth and, thereby, the impact on oil demand growth.

The Fed news likely contributed to a stronger dollar, which has also been weighing on oil prices this week. The dollar index, which compares the value of the U.S. Dollar to six foreign currencies, surged to a three-month high.

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. We do not ignore this possibility. Our favorite scenario, which is modestly bullish, is one where there is 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. It makes the market vulnerable to upsets in the daily flow of oil supply.

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 slides below $2.00; first time since 2020

The March Henry Hub contract continued to slide lower this week, falling below $2.00/MMbtu on Tuesday before rallying into the end of the week. Prices on Tuesday traded as low as $1.987/MMbtu but settled at $2.073/MMbtu. It was up from there. The prompt month contract rallied by 37c to finish the week at $2.440/MMbtu. The Summer ’23 strip finished the week up 17c at $2.908/MMbtu, and the Winter ‘23/’24 strip climbed 9c to settle at $3.836.

Several public companies reported their quarterly earnings this week, explaining how they are reacting to the decline in gas prices. Notably, producers Chesapeake Energy and Comstock Resources lowered their 2023 production guidance and said they would reduce drilling activity. Each company will drop two rigs in the Haynesville region. Judging by private conversations with AEGIS clients, it is likely that more producers will consider reducing activity.

Prices are weak, but at least some demand is coming back. The restart of the Freeport LNG export facility appears to be well underway. The plant took the largest volume of gas this week since the June fire, coming in at 700 MMcf/d on Friday. Freeport has already loaded several cargoes (slowly) and received regulatory approval to restart two of its three liquefaction trains, leading many market participants to expect a full restart of the 2.1 Bcf/d facilities in March.

AEGIS recommends hedging natural gas via swaps in the summer months and collars in the winter. By utilizing costless collars in the winter, a producer can capture added value from the relatively higher-priced call options. This will allow for a collar with a higher ceiling price than would otherwise be available in a skew-neutral market.