Opinion: Risks rise as hedge funds place record bet on oil

Hedge funds increased net long positions in Brent and WTI derivatives

Hedge funds

Hedge funds are more bullish now than at any time since oil prices started falling in the summer of 2014. Anadarko photo.

By John Kemp

LONDON, May 3 (Reuters) – Hedge funds increased their net long positions in Brent and WTI derivatives by 7 million barrels to a record 663 million barrels in the week ending April 26.

Even though oil prices have already risen by roughly $20 per barrel (70 percent) from their low in January, hedge funds are more bullish than at any time since oil prices started slumping in the summer of 2014.

COMBINED BRENT AND WTI POSITIONS (LONG AND SHORT)

Hedge funds and other money managers held futures and options contracts equivalent to 791 million barrels of crude betting on a further rise in prices and just 128 million barrels gambling on a fall.

The record net long position in crude easily surpasses previous peaks set in May 2015 (572 million barrels) and June 2014 as ISIS fighters threatened the oilfields of Iraq (626 million barrels).

Large concentrations of long or short positions are often followed by a sharp reversal in prices when holders try to lock in their profits by liquidating some of their positions, triggering a rush for the exit.

The accumulation of such a large net long position over the last 17 weeks could indicate an increasing risk crude prices will pull back and give up at least some of their recent gains in the short term.

CHART A

Crude prices have been closely correlated with the accumulation and liquidation of hedge fund positions in Brent and especially WTI since the start of 2015.

Traders and analysts are divided over whether hedge funds and other money managers are now fully invested in crude, heightening the risk of reversal, or could still increase their position further.

Since the start of the year, hedge funds have added almost 195 million barrels of additional long positions in Brent and WTI, while cutting short positions by 235 million.

The brutal squeeze on former hedge fund short positions has been at least as important as the emergence of fresh long positions in pushing prices higher.

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But with hedge fund short positions down from a recent peak of 392 million barrels in the second week of January to just 128 million barrels there are not many more short positions to squeeze.

On the long side, hedge funds have already amassed a record number of contracts. Past experience indicates that this could be a close to their maximum position.

But oil prices are less than half of the level that they were in June 2014, so the dollar amount of hedge fund positions is still relatively modest, which could indicate they have further scope to add long positions.

On balance, the hedge funds’ record net long position has shifted the balance of price risks towards the downside in the short term.

But it has to be set against the fundamental supply-demand picture, where the balance of risks appears to be shifting to the upside (“Oil rally is not just about hedge funds”, Reuters, April 29).

U.S. gasoline consumption averaged 9.2 million barrels per day in February, stronger than expected, according to monthly data published by the U.S. Energy Information Administration on April 29.

US GASOLINE CONSUMPTION (MONTHLY)

U.S. gasoline consumption is running at a record for the time of year.

Record gasoline consumption in the United States is consistent with separate data showing traffic volumes on U.S. highways rising by between 5 percent and 6 percent year-on-year in February.

Even if the strength of implied gasoline demand and driving in February was flattered by baseline effects, there is no doubting the underlying strength of fuel demand from U.S. motorists.

At the same time, U.S. oil production has fallen by more than 3 percent over the last 12 months and is down almost 570,000 barrels per day (6 percent) from its peak (“Petroleum Supply Monthly”, EIA, April 29).

So far this year, the hedge funds and market fundamentals have both been pushing in the same direction.

The liquidation of previous hedge fund short positions and accumulation of long ones has accelerated a rise in crude prices that would probably have occurred in any event given the gradual rebalancing of the physical crude market.

But it is no longer obvious hedge funds and fundamentals will work in the same direction in the next couple of months.

There is now some tension between hedge fund positioning (which suggests price risks are biased to the downside in the short term) and the tightening supply-demand balance (which indicates price risks could still be tilted to the upside).

(Editing by David Evans)

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