Reuters logo
Oil becoming a crowded trade as hedge funds pile in: Kemp
February 7, 2017 / 2:49 AM / 8 months ago

Oil becoming a crowded trade as hedge funds pile in: Kemp

A flame shoots out of a chimney at a petro-industrial factory in Kawasaki near Tokyo December 18, 2014. Brent crude held steady above $61 a barrel on Thursday, bringing a sharp drop in prices to a temporary halt as companies are forced to cut upstream investments around the world. REUTERS/Thomas Peter (JAPAN - Tags: BUSINESS ENERGY)

LONDON (Reuters) - Hedge funds have accumulated a record bullish position in crude futures and options, betting on further price rises, but the lopsided nature of the positioning has become a key source of risk in the oil markets.

Hedge funds and other money managers had accumulated a record net long position in the three main Brent and West Texas Intermediate (WTI) futures and options contracts equivalent to 885 million barrels by Jan. 31 (tmsnrt.rs/2kiH2WU).

Fund managers added an extra 41 million barrels to their net long position in the seven days to Jan. 31, according to the latest reports published by regulators and exchanges.

Funds now have long positions equivalent to almost 1 billion barrels across the three major contracts, while short positions amount to just 111 million barrels.

The ratio of long to short positions has reached almost 9:1, the most bullish since May 2014, when Islamic State fighters were racing across northern Iraq and the Libyan civil war had halted crude exports (tmsnrt.rs/2jTBZgO).

The crude market is starting to resemble the classic crowded trade in which speculators attempt to position themselves in the same direction in anticipation of a big price move.

There has been no sign of profit-taking although Brent prices have risen close to the $55-60 region most energy market professionals expect to be the average for 2017.

Hedge funds have continued to add long positions even though Brent prices have almost doubled over the last 12 months and are trading near the highest level since July 2015.

And there is no evidence of any new wave of short sales. Combined short positions across Brent and WTI have fallen to the lowest level in seven months.

Fund managers apparently believe output reductions by the Organization of the Petroleum Exporting Countries and other exporters will succeed in draining excess global inventories and pushing prices higher.

Managers are also discounting the threat from renewed drilling in the United States and a likely increase in output from shale producers, at least in the near term.

But every successful trade needs an exit strategy and in this case it remains unclear how and at what price fund managers will manage down positions and try to take profits.

The enormous concentration of hedge fund long positions has emerged as an important source of price risk in the near term (“Predatory trading and crowded exits”, Clunie, 2010).

One-way markets, when traders attempt to position themselves in the same direction, often precede sharp reversals in prices (“Why stock markets crash: critical events in complex financial systems”, Sornette, 2003).

The previous record net long position in oil markets, set in June 2014, preceded the deepest and most prolonged slump in prices for almost 20 years (tmsnrt.rs/2kiSP7t).

And in the last two years, large concentrations of short positions have normally preceded a sharp short-covering rally as managers raced to lock in profits when prices stopped falling.

With so many fund managers now positioned in the same (long) direction, the risk of a rush for the exits, a disorderly liquidation of positions and a correction in prices has risen significantly (tmsnrt.rs/2kiGlNm).

Editing by Dale Hudson

Our Standards:The Thomson Reuters Trust Principles.
0 : 0
  • narrow-browser-and-phone
  • medium-browser-and-portrait-tablet
  • landscape-tablet
  • medium-wide-browser
  • wide-browser-and-larger
  • medium-browser-and-landscape-tablet
  • medium-wide-browser-and-larger
  • above-phone
  • portrait-tablet-and-above
  • above-portrait-tablet
  • landscape-tablet-and-above
  • landscape-tablet-and-medium-wide-browser
  • portrait-tablet-and-below
  • landscape-tablet-and-below