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Liquidation risk hangs over oil and gas prices – Kemp

Liquidation

Liquidation

Last peak in hedge funds’ long-short ratio in natural gas heralded the start of big slide in prices

By John Kemp

The threat of liquidation hangs over oil and gas prices in the short term as hedge funds have built the most bullish positions in both commodities since 2014.

Hedge funds are running enormous net long positions in crude and gas even though prices have risen sharply in the last year, and they may have reason to expect further price strength in 2017.

But gains in both commodities seem to have stalled recently and supply will increase as shale drilling picks up (“U.S. shale oil and gas sector surges back to life”, Reuters, Jan. 23).

More importantly, the build-up of such large long positions has become a key source of downside price risk if and when hedge funds close some of them to take profits.

At the very least, the overhang of long positions could slow further price rises.

THE BIG OIL LONG

Hedge funds and other money managers boosted their combined net long position in Brent and West Texas Intermediate (WTI) futures and options by 58 million barrels to a record 834 million barrels in the week to Jan. 17.

Fund managers hold bullish long positions equivalent to 960 million barrels and bearish short positions amounting to just 126 million, according to an analysis of records published by regulators and exchanges.

The ratio of long to short positions stands at 7.6:1, down slightly from a recent peak of 8:1 in December, but otherwise the most bullish since oil prices started sliding in June 2014.

Fund managers made few changes in their positions in the three major Brent and WTI contracts in the week to Jan. 17, with one glaring exception.

One or more funds added a spectacular 50 million barrels of long positions in the main WTI contract on the New York Mercantile Exchange.

The number of extra long positions was the most added in a single week since at least seven years ago, according to regulatory data.

There was no obvious fundamental reason for hedge funds to add so many extra long positions in WTI contracts and not Brent.

One possible technical explanation is that fund managers are gambling on the implementation of a border tax adjustment in the United States that would push up the price of U.S. crude relative to Brent.

But there was no corresponding increase in short Brent positions and the intention of fund managers adding extra WTI long positions may never be known for certain.

Whatever the cause, the build-up of large long (or short) positions in futures and options has normally preceded a sharp reversal in crude prices over the last two years.

Crowded trades are often a signal that prices are about to reverse (“Predatory trading and crowded exits“, Clunie, 2010).

NATURAL GAS BULLS

Crude is not the only market where hedge fund bullishness is starting to look like it could trigger a near-term correction.

Hedge funds also increased their net long position in U.S. natural gas by the equivalent of 280 billion cubic feet to 3.042 trillion cubic feet in the week to Jan. 17.

Hedge funds have established the largest net long position in U.S. gas futures and options since May 2014.

The ratio of long to short positions has surged to 4.23:1, from just 1.57:1 in the middle of November, and is the highest since February 2014.

Since the start of 2010, the long-short ratio has been this high only once before, and then only for a single week, according to an analysis of data published by the U.S. Commodity Futures Trading Commission.

The last peak in hedge funds’ long-short ratio in natural gas heralded the start of a big slide in prices.

liquidation

Ph: 432-978-5096 Website: www.mapleleafmarketinginc.com

Posted in: Energy Financial

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