Week Ending February 9

Geopolitical Risk “Premium” Returns to Oil as Cease-Fire Talks Face Setbacks

March ’24 WTI gained $4.56, or 6%, this week to finish at $76.84/Bbl. Prospects for a ceasefire in the Israel-Hamas conflict faded as Israeli Prime Minister Netanyahu rejected Hamas’ proposed terms and prepared to advance Israel’s military campaign to southern Gaza.

Increased Houthi attacks on merchant ships in the Red Sea have prompted warnings from major shipping companies about the worsening security situation in the Red Sea.

Analysts continue to monitor potential threats to supplies amid heightened Middle East tensions following US strikes in Yemen. This comes as Netanyahu said he sees “no other solution than total victory” and Iraq's threat to withdraw from the American-led coalition.

Additionally, the Biden administration is mulling stricter sanctions enforcement on Iran’s nearly 1.5 MMBbl/d oil exports to curb its support for militias in the Middle East.

The military escalations in the Middle East brought back the risk premium into oil prices despite no material supply disruption so far. Nonetheless, the continued risk of further escalations could lead to volatility in front-month oil prices.

Furthermore, EIA, in its monthly STEO report, reduced its 2024 U.S. oil (liquids) production growth forecast to 0.16 MMBbl/d from an earlier 0.27 MMBbl/d. If accurate, EIA’s modest U.S. oil production growth forecast, which counters IEA’s forecast of nearly 0.7 MMBbl/d growth, could support prices.

With OPEC+ starting additional production cuts, 0.34 MMBbl/d in Jan (Platts), which was the steepest drop in six months, AEGIS is modestly bullish on the curve and expects the oil market to be in a deficit in 2024.

Natural Gas Prices Plunge Below $2/MMBtu 

Persistently high levels of supply combined with weak demand have resulted in a cratering of nearby contracts. The March 2024 Henry Hub contract fell to an all-time low this week, settling 23c lower at $1.85/MMBtu. The Summer ’24 strip finished the week down 24c at $2.26/MMBtu, and the Winter ‘24/’25 strip lost 16c to settle at $3.38/MMBtu.  Given the fall in prices, we have recently shifted our bearish Summer ’24 view to a neutral position, but a further price decline is not implausible, nor would it be unprecedented. Our outlook for Winter ‘24/’25 remains bearish. 

Prices have likely fallen low enough to maximize coal-to-gas switching and potentially low enough to encourage some producers to begin shutting in wells where the economics have deteriorated. With a large amount of coal capacity being retired or scaled down, the amount of coal-to-gas switching capacity has decreased significantly from previous years. In 2023 alone, 9.5 GW of coal was retired, representing almost 5% of the total coal-generating capacity, although many of those plants have been operating well below capacity. A historically smaller balancing mechanism from the power sector could mean a supply reduction may be necessary to prevent further price deterioration.  

The production growth in 2023 caught many by surprise and led to market balances reaching further levels of oversupply than was already occurring. Recent data from S&P shows production around 104.5 Bcf/d, and if output remains at this level, gas storage levels may rise even higher than in 2023. Our current storage estimate assumes an average production rate of 103 Bcf/d throughout 2024, along with ten-year average weather leads to a summer 2024 starting point of 1.95 Tcf and a winter 2024/2025 starting point of 4.00 Tcf. This would be a more bearish setup than the start of winter 2023/2024. 

AEGIS recommends hedging natural gas with collars in the winter and swaps in the summer months. With prices trading significantly lower and our Summer ’24 view becoming neutral, we have started to receive questions about monetizing hedges that are in the money. While this may make sense for some clients, we do not necessarily recommend this as there is still a risk of prices continuing to fall.