Concentration of so many hedge-fund long positions poses a downside risk to prices if rally should stall
By John Kemp
LONDON (Reuters) – Hedge funds have amassed a record bullish position in crude oil in anticipation OPEC and non-OPEC oil producers will succeed in rebalancing the market and reducing excess stocks next year.
Fund managers accumulated a net long position equivalent to 796 million barrels in the three main futures and options contracts linked to Brent and West Texas Intermediate by Dec. 13.
The net position has almost doubled from a low of 422 million barrels four weeks earlier, according to an analysis of data from regulators and exchanges.
Hedge funds raised the number of bullish long positions betting on a rise in oil prices by 148 million barrels in the course of four weeks.
Over the same period, the number of bearish short positions betting on a price fall has been cut by 226 million barrels.
Long positions hit a record of 923 million barrels, while short positions were at the lowest level in six months.
Since mid-November, Saudi Arabia and other producers have engineered the biggest turnaround in oil market sentiment for at least a quarter of a century.
Promised production cuts totalling almost 1.2 million barrels per day (bpd) by the Organization of the Petroleum Exporting Countries and 560,000 bpd by non-OPEC producers have transformed traders’ views.
Formerly bearish funds with short positions have been brutally squeezed and forced to close out by the sharp rally in prices.
In their place, bullish fund managers have accepted the argument that OPEC and its rivals will accelerate oil market rebalancing by freezing or cutting output from January 2017.
TIME TO DELIVER
Doubts about the effectiveness of the output curbs, cheating and the pace of rebalancing have been suppressed, at least for the time being.
However, the scale of the hedge funds’ long positions and the lack of short positions has emerged as a risk factor in its own right.
The balance of risks in the oil market has shifted to the downside from a hedge-fund positioning perspective.
There are no more short positions to squeeze, which removes one important source of upward pressure on oil prices.
Fund managers have closed out all the short positions that were established between mid-October and mid-November.
At the same time, the concentration of so many hedge-fund long positions poses a downside risk to prices if the rally should stall and fund managers try to lock in some profits by liquidating part of their holdings.
Fundamentals may continue to push oil prices higher, but the concentration of long positions will overhang any further gains.
OPEC and non-OPEC producers have driven doubters to the sidelines while convincing most fund managers they can deliver enough cuts to speed up rebalancing.
But so far OPEC and its rivals have been raising rather than lowering their output before the curbs are due to start.
Now the challenge is to deliver enough cuts to justify that confidence and validate the long positions, or risk a correction lower.
(Editing by Dale Hudson)