Oil Speculators Run Out of Reasons to Bet on Rising Prices

March 2016, Vol. 243, No. 3

Oil prices plunged to their lowest levels in a month on April 4, falling back from recent highs to the mid-$30s per barrel.

Oil traded down on the sinking prospect of an outcome from the Doha summit April 17, where several key OPEC countries will meet with Russia to discuss the pending production freeze agreement. Optimism faded on the deal, following remarks from Saudi Deputy Crown Prince Mohammed bin Salman, who said in a wide-ranging interview with Bloomberg that Saudi Arabia would only agree to freeze its production levels if Iran also participated.

That was never going to happen though, with Iran finally free of western sanctions and looking to ramp up production by 1 MMbpd over the next year or two. Iran’s oil minister announced this week that Iran is well on its way to that goal, having increased oil and condensate exports by more than 250,000 bpd in March. That figure is likely exaggerated, but the trend is clear.

More than a few analysts have warned warned over the past two months that the OPEC-Russia “freeze deal” would not amount to much. It has been relatively clear since the start that the major countries involved – Saudi Arabia, Russia, Qatar, Venezuela – except for the Saudis, have limited ability to increase production even if they wanted to. The oil markets seemed to ignore that fact, and oil prices surged by 50% between early February and late March.

Along the way, oil speculators took incredibly bullish bets on oil, bidding up prices as they closed out their short positions. Over a seven-week stretch, oil traders posted the largest liquidation of shorts on record. In that sense, the rally was driven largely by sentiment, less so by fundamentals. Oil still remains oversupplied, with global production exceeding demand by some 1.5 MMbpd.

Crude oil storage levels continue to climb, once again hitting a fresh record in the last week of March to reach 534 million barrels. Oil traders struggled to find a new reason to keep oil above $40 per barrel. U.S. Federal Reserve Chair Janet Yellen provided a small reason to keep oil afloat last week when she seemed to back off previous commitments to raise interest rates multiple times this year.

But with the fundamentals not improving for the oil markets, prices increasingly looked detached from reality. And with speculation having been the key driver of the latest rally, the more than $40 price levels seemed to be unsustainable. Indeed, last week spot prices began to fall. The comments from Saudi Deputy Crown was the catalyst to what could be an unfolding sell off, puncturing the positive sentiment that had built up in recent weeks. WTI closed out April 4 down 4%, hitting its lowest level since early March.

The renewed bearish sentiment is evident in the trading data. For the week ending  March 29, net-short positions rose by the most since November, according to CFTC data, jumping by 11,167 contracts, or 17 percent. Net-long positions fell by 6.3%.
“We switched to a moderate flow of selling by money managers,” Tim Evans, an energy analyst with Citi Futures Perspective, told Bloomberg. “It was dominated by new shorts coming into the market and not by long liquidation. The rise in shorts may reflect that they think the rally is done.”

A trend toward more bearish bets could be coming soon. “Speculative financial investors who had bet on a rising oil price in anticipation of an agreement…are likely to withdraw again in view of this latest situation,” Commerzbank wrote in a note to clients.

To be sure, over the long-term oil prices are unsustainably low, with so many drillers not turning a profit right now. Oil production is falling in the United States, in Latin America, and in some OPEC countries. Prices will have to rise. But there is still some ways to go. Until then, the sharp rallies in prices could be followed by sell offs, with the one consistency being volatility.

By Nick Cunningham, Oilprice.com

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