Saturday, June 24, 2017

Hedge Funds Rush for Exit After Oil Trade Becomes Crowded

Posted by March 20, 2017

Hedge funds cut their bullish bets on oil by the largest amount on record in the week to March 14, according to the latest data published by regulators and exchanges.

Hedge funds and other money managers cut their combined net long position in the three main futures and options contracts linked to Brent and WTI by a record 153 million barrels in just seven days.

The reduction in the net long position coincided with the sharp fall in oil prices, which started on March 8 and continued through March 14.

The adjustment was split almost evenly between the liquidation of old long positions and the establishment of new short positions.

Hedge fund managers reduced long positions by 84 million barrels while short positions were increased by 70 million barrels.

Fund managers' net long position has been reduced by a cumulative total of 230 million barrels over the last three weeks from a peak of 951 million barrels on Feb. 21.

Most fund managers are still bullish about the outlook for oil but that bias is less pronounced than it was a month ago.

Hedge fund long positions outnumber short positions by a ratio of 4.4:1, but that come down from a ratio of 10.3:1 on Feb. 21.
 
Flush Out
Before the recent sell off, hedge fund managers had boosted their net long position in Brent and WTI by 530 million barrels between the middle of November and the middle of February.

Funds amassed a record 1.05 billion barrels of long positions, while short positions were cut to just 102 million barrels, the smallest number since oil prices started slumping in 2014.

But large concentrations of hedge fund positions, and an imbalance between the long and short sides of the market, often precede a sharp reversal in oil prices.

A sharp selloff in oil prices had been widely anticipated for some time before it actually occurred ("Hedge fund positioning in oil looks stretched", Reuters, Feb. 7).

Crude oil prices and hedge fund positions seem to have reached a turning point about two weeks before the sharp drop in oil prices on March 8.

Brent spot prices, calendar spreads, and the spread between Brent and Oman futures all reached a turning point on, or shortly after, Feb. 21.

The first new hedge fund short positions began to emerge after Feb. 21, with 25 million barrels of Brent and WTI short positions added in the week to Feb. 28.

Funds added another 17 million barrels of short positions in the week to Mar 7, then an extra 70 million in the week to March 14.

The selloff in Brent and WTI prices, which was barely perceptible at first, developed a momentum of its own and turned into an avalanche on March 8.

Accelerating liquidation of long positions, emergence of new short positions, and a sudden drop in prices are all hallmarks of a trade that had become crowded, culminating in a rush for the exit.

The subsequent reduction in the hedge funds' net long position and sharp fall in prices has removed much of the short-term positioning risk that had been hanging over the oil market for the last two months.

Now that the predicted rush for the exits has occurred, and some of the froth has blown off the market, the outlook for oil prices is looking much more balanced than a few weeks ago.
 
(By John Kemp)

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