By John Kemp
Oil prices are set to remain under pressure until Saudi Arabia and the rest of OPEC prove they can show how they will remove enough barrels from the market to accelerate the rebalancing process.
Benchmark Brent futures prices surged more than $8 per barrel over the course of nine trading sessions after OPEC members announced a surprise framework agreement on Sept. 28 to cut production.
The agreement caught hedge funds and other money managers off guard with an unusually large number of short positions, which helped squeeze the market higher in a blistering short-covering rally.
On the eve of the OPEC meeting, hedge funds had short positions in the main Brent and WTI futures and options contracts equivalent to 267 million barrels of crude.
Over the next 21 days, those positions were squeezed to just 138 million barrels, according to an analysis of position data published by regulators and exchanges, leaving hedge fund and other money manager short positions close to their lowest levels for two years.
Over the same period, hedge fund long positions climbed from 737 million barrels to 825 million barrels, with the addition of new long positions fuelling the rally.
The speculative community has now shifted from being very short on the eve of the OPEC meeting to being very long.
By the middle of Oct., after taking account of short positions, hedge funds had a net long position in Brent and WTI futures of 689 million barrels, the largest on record.
From a positioning perspective, the balance of risks had shifted from the upside to the downside by the middle of the month.
In the most recent week, ending on Oct. 25, hedge funds cut their net long position by a total of 42 million barrels.
Commentators have seized on the slow progress towards reaching a detailed plan allocating output cuts between OPEC and non-OPEC members to explain the fall in prices.
In truth, once prices stopped climbing, it was always likely some hedge funds would take profits and reduce their long positions, creating self-fulfilling downward pressure on prices.
In a momentum-driven market, once prices stop climbing (or falling) they are apt to correct.
OPEC’s failure to provide more details on how the production sharing agreement would work helped stall the rally and initiate the pull back but the market was primed to retreat anyway.
Crude prices are likely to remain under pressure in the short term until more of the record net long positions have been liquidated, or until OPEC can provide convincing details of how the output agreement will work.
The hedge fund community still has a strong bullish bias towards oil on the expectation the supply-demand balance will tighten and lift prices during 2017.
Nothing has happened to change that fundamental outlook from the perspective of the hedge fund community.
But with so much bullishness already priced in and hedge funds already very long, many fund managers are becoming cautious until OPEC spells out how the output agreement will work.