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August 8, 2016

Hedge Funds Turn Record Short on Oil

Oil prices rose Monday as modestly stronger margins for refiners provided support to the market despite the continuing glut of crude supply. The October contract for global benchmark Brent gained 1.3% to above $45 a barrel, while U.S. counterpart West Texas Intermediate increased 1.4% above $42.50 for September deliveries.

Several factors have boosted oil prices over the past three trading days. Among the more trivial ones, Olivier Jakob from Swiss-based Petromatrix was cited by the WSJ noting the improvement in the gasoline crack margin, a technical term for the price difference between crude oil and the figure refiners charge for gasoline, as providing a tailwind for the market. “The gasoline crack [margin] has rebounded and stabilized and this has relieved the pressure on oil prices a little bit,” he said. “This week has some upside potential [for oil prices], but the fundamentals are not there for any sustained recovery.” That said, he noted that the fundamentals for gasoline hadn’t changed and there was a large global oversupply, which should keep prices below $45 a barrel.
However, the key catalyst for today's spike is another convenient report by OPEC, according to which the oil exporting organization will hold informal talks at an energy conference in September, the cartel’s president said Monday, as oil-producing nations worry over a recent downturn in the crude market. OPEC is always discussing ways to stabilize the market, said Qatar’s energy minister, Mohammed bin Saleh al-Sada, who is serving as the 14-nation oil cartel’s president this year.
Of course, oil traders are familiar with OPEC strategy of "leaking" such supply cut reports just as oil is headed for key support levels, aimed largely at headline scanning algos, and so far today the verbal intervention has managed to push oil higher. A similar initiative died back in April during talks in Doha, Qatar, when Saudi Arabia backed out over Iran’s refusal to join in a so-called production freeze until it had reached pre-sanctions levels of oil output. Under the freeze, countries would have agreed to limit their production to certain levels in a bid to raise oil prices by constricting the amount of crude on the market.
“OPEC continues to monitor developments closely, and is in constant deliberations with all member states on ways and means to help restore stability and order to the oil market,” Sada said. “Expectation of higher crude oil demand in the third and fourth quarters of 2016, coupled with decrease in availability, is leading the analysts to conclude that the current bear market is only temporary and oil price would increase during later part of 2016,” he added,
Several OPEC members want to revive the idea of setting new limits on oil production this autumn as Iran regains much of the energy-industry might it lost during the years of Western sanctions, The Wall Street Journal reported last week.
The nations—which include Venezuela, Ecuador and Kuwait—want to take another stab at cooperation with non-OPEC members like Russia. What makes today's announcement somewhat different is that unlike last week, when this proposal was first floated, today's iteration seemed to get some tacit approval by Russia, as Reuters reported earlier:
But the biggest threat to oil's recent price decline is that, like in February, hedge funds are now massively short. In fact, according to Bloomberg, hedge funds have gone all-in on lower oil prices, counting on seasonal weakness to play out again this year. Specifically, money managers increased wagers on declining crude prices to a record as futures dropped to the lowest in more than three months.
Hedge funds increased their short position in West Texas Intermediate crude to 218,623 futures and options combined during the week ended Aug. 2, the highest in data going back to 2006, according to the Commodity Futures Trading Commission. Money managers’ short position in WTI rose 38,489 futures and options and have almost doubled in the past three weeks, CFTC data show. Longs, or bets on rising prices, increased 1.6 percent, while net longs dropped 28 percent to the lowest since January.

The reason for the renewed bearish sentiment is fundamentals: crude inventories climbed for a second week as imports arrived at the fastest pace since 2012. The supply gain comes on the cusp of seasonal refinery maintenance that will curb crude demand. Futures have declined in each of the past five Septembers. "We’re are entering a period of seasonal maintenance, which should put some downward pressure on prices," said Scott Roberts, co-head of high yield investments and manager of $2.7 billion at Invesco Advisers Inc. in Atlanta. 
The problem, however, is that as recent history has shown, any time shorts pile in, even the smallest trace of bullish news leads to a significant short covering squeeze, one which takes the price of oil materially higher, and juding by the price action this morning, this time may not be any different: at last check WTI had jumped over 1%, in the mid $42 range, and rising rapidly, a move which may continue if incremental shorts fail to appear.
Courtesy of Tyler Durden, founder of Zero Hedge
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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