Hedge funds have built record or near-record bullish positions in almost all parts of the petroleum complex anticipating that prices will keep rising.
Hedge funds and other money managers had amassed a net bullish position in crude and refined products amounting to more than 1 billion barrels of oil as of Oct. 31 (http://tmsnrt.rs/2hgNlvd).
Portfolio investors held a net long position in the five major petroleum futures and options contracts amounting to 1,022 million barrels, according to records published by exchanges and regulators on Friday.
The net long position in the five major contracts covering Brent, WTI, gasoline and heating oil has surged by almost 720 million barrels since the end of June and is now just 3 million below the record of 1,025 million set in February.
Bullish records or multi-year highs are being set all over the place:
Long positions in Brent are at a record 587 million barrels.
Net long position in Brent is at a record 530 million barrels.
Long positions in gasoline are at a record 107 million barrels.
Net long position in gasoline is the highest since April 2014.
Long positions in heating oil are at record 84 million barrels.
Net long position in heating oil is at a record 68 million barrels.
Fund managers have continued adding to bullish positions even as benchmark Brent prices have climbed to the highest level since July 2015.
Most investors appear to believe prices are moving into a new and higher trading range and want to ride the rally until the new price ceiling is discovered.
The concentration of long positions creates a significant risk of a sharp price reversal if and when portfolio managers attempt to realise some of their profits.
But the bulls can cite some fundamental factors that might drive prices higher first. Global demand is growing strongly. Inventories of both crude and products are declining rapidly. And the U.S. rig count is declining.
OPEC sources have indicated that production cuts will be extended and "$60 should be the floor for oil prices next year" ("OPEC likely to keep oil supply curbs for whole of 2018”, Reuters, Nov. 1).
If OPEC is targeting a floor of $60, then the average price and ceiling will be significantly higher, perhaps $70 or more.
The wave of ministerial changes and arrests in Saudi Arabia at the weekend is also likely to make the kingdom more hawkish on prices.
Given internal political tensions, the kingdom's rulers can ill-afford a renewed drop in oil prices or further austerity.
Policymakers need higher revenues, a swift return to economic growth and lots of job creation to maintain stability and support for the bold social and economic transformation plan.
The kingdom would probably be much more comfortable with a rise in prices to $70 (even at the risk of reviving U.S. shale production) than with a renewed decline to $50 (and the return of austerity).
Recent events have heightened the existing asymmetry in the kingdom’s policy preferences: policymakers will probably be more comfortable risking over-tightening the oil market
than under-tightening it.
In the circumstances, it is hardly surprising that hedge funds have amassed record bullish positions, even as the risk of an abrupt reversal is increasing.
By John Kemp