Week Ending March 3

Oil advances four-day rally as demand optimism bolsters China bulls

Oil snapped a two-week losing streak. The April ’23 contract gained $3.36 on the week to finish at $79.68/Bbl. Optimism surrounding China’s economic recovery and Russia’s supply risk continues to offset concerns of an economic slowdown.

Oil remains range-bound despite the lack of a clear fundamental driver. Chinese demand recovery continues to remain in focus. This week's rally was likely fueled by strong manufacturing data coming out of China that indicates a swift recovery in demand.

On the supply side, Russia is facing challenges finding new buyers for its refined products despite its crude exports defying western sanctions. According to Kpler’s ship tracking data, as much as 3.2 MMBbl (which is usually around 0.7-0.8 MMBbl) of Russian diesel-type fuel is afloat on the sea with no declared destination. In addition to this, Kremlin’s retaliatory 0.5 MMBbl/d output cut this month is expected to further affect exports.

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.

Wow. The April ’23 natural gas contract is up 38% to $3.00/MMBtu in eight trading days!

Most of the rally is likely due to more bullish March weather forecasts, the quick ramp-up of Freeport LNG, and technical trading off 12-month lows. The April Henry Hub contract finished the week higher by $0.46/MMbtu, but the threat of underlying bearish fundamentals remains.

While the winter heating season is coming to a close, weather forecasts indicate March could be cooler than average, leading to a boost in demand. The most recent two-week forecast ending March 16 indicates a total of 324 heating degree days (HDDs are a measurement of weather-driven demand) compared to the ten-year normal of 247 for the corresponding period. Each HDD can be worth about 2 Bcf in peak winter.

At the same time that forecasts began to show cooler weather, the long-idled Freeport LNG export facility increased flows to more than 1.50 Bcf/d, bringing total gas volumes to US export facilities to a new record high of 14 Bcf/d. The company has made its final request to FERC, which, once approved, will enable Freeport to take up to 2.1 Bcf/d.

Bullish catalysts may have driven gas prices up from the lows, but the specter of oversupply remains. The EIA reported a storage withdrawal of -81 Bcf, which is 91 Bcf, smaller than the five-year average. Total gas storage is now nearing the top of the five-year range and is at a surplus of 342 Bcf to the five-year average.

AEGIS recommends taking advantage of this rally in gas prices by adding hedges using either swaps or collars depending on the tenor and the client’s goals. Costless collars are recommended for winter months, given elevated call skew, which allows for a higher floor price, while we recommend swaps be used in the summer months to gain an added level of protection.