West Texas Intermediate plunged by over $10/Bbl this week, the first weekly decline in two months. A variety of factors are likely responsible here for the sharp decline, but front and center is Fed action.
Federal Reserve Chair Powell reiterated his plan to curb surging inflation with more aggressive rate hikes. On Friday, Powell said the Fed is focused on returning to a 2% inflation target. Restrictive monetary policy often leads to an economic downturn and could damage oil demand. The Fed raised short-term interest rates by 75 bps on Wednesday, the largest hike in over three decades.
Recession or non-recession-related demand destruction remains our top bearish risk. But the fundamental backdrop for crude oil and related products is still bullish. Stocks for all petroleum globally are low and an ample supply response is uncertain. We remain bullish on the curve based on the idea that supply is scarce, amid low inventories. The U.S. liquids growth can only contribute so much, and it takes time; OPEC is having trouble meeting its own output quota. According to the IEA, the Saudis and U.A.E. only have 2 MMBbl/d in combined spare capacity past their OPEC+ quota. That is only 2% of the global supply. Combining the low OPEC spare capacity with external pressures on Russia, supply may be hard to find in the next few years.
AEGIS hedge recommendations are still costless collars. Using collars provides the benefit of protecting producers to the downside but allows the bullish thesis (and fighting backwardation) to play out and capture potentially higher prices than current swaps would allow.