(John Kemp is a Reuters market analyst. The views expressed are
* Chart 1: tmsnrt.rs/2gwFSXn
* Chart 2: tmsnrt.rs/2hm1C5f
* Chart 3: tmsnrt.rs/2hm4zT1
By John Kemp
LONDON, Dec 12 Hedge funds were badly caught out
by the production cuts announced by OPEC at the end of last
month, triggering a furious rally as managers raced to buy back
loss-making short positions.
When OPEC announced a deal had been reached on Nov. 30, a
substantial number of short positions were still uncovered,
providing the opportunity for a classic squeeze.
Now the hedge fund community has turned its bearish position
going into the meeting into the largest bullish position on
Hedge funds and cut their short positions in Brent and WTI
futures and options by 134 million barrels in the week to Dec. 6
Fund managers also added 94 million barrels of fresh long
positions, according to positioning data published by regulators
The shift from short-to-long amounted to a record 228
million barrels in a single week, and took the total net long
position to 728 million barrels, which was also a record (tmsnrt.rs/2hm1C5f).
There has never been a comparable shift from bearishness to
bullishness among speculators over such a short space of time in
the last 25 years.
The scale of the turn round explains why Brent prices jumped
by more than $7.50 per barrel or 16 percent in the week
following the OPEC meeting.
USING SHOCK AND AWE
By the end of Dec. 6, however, most hedge fund short
positions in Brent and WTI had been closed out, which explains
why the upward momentum which had carried prices higher began to
The faltering rally left Brent trading below $54 per barrel,
which probably disappointed Saudi Arabia and other OPEC members,
hoping to be rewarded with a bigger jump.
Most analysts and traders expected OPEC to deliver only
around half of the promised cut of 1.2 million barrels per day
("OPEC expected to deliver only half of target production cut",
Reuters, Dec. 6 ).
As a result, crude stocks were expected to remain high
throughout the first half of 2017, before starting to draw down
in the second half ("Oil traders see no market rebalancing until
later in 2017", Reuters, Dec. 8 ).
But the announcement of a deal between OPEC and non-OPEC
countries on Dec. 10 has given the rally renewed momentum.
Saudi Arabia has sought to drive oil prices higher again
using "shock and awe" tactics by assembling unexpectedly large
production cuts from an unusually broad group of non-OPEC
Eleven non-OPEC countries have pledged to reduce their oil
output by a combined total of 558,000 barrels per day,
voluntarily or through managed decline, starting in January
Most of the cuts and declines will come from Russia, Mexico
Oman and Azerbaijan with token contributions from other
Production cuts will initially last for six months, but will
be extendable for a further six months, depending on market
conditions, according to a press statement released by OPEC.
Output reductions will be carried out concurrently with cuts
of almost 1.2 million barrels per day agreed by OPEC at the end
of November ("OPEC deal expected to tighten oil market in 2017",
Reuters, Dec. 1 ).
The global agreement is intended to accelerate oil market
rebalancing by drawing down some of the excess inventories built
up over the last two years.
Some analysts have expressed doubts about whether the deal
really will cut crude oil supplies and reduce stock levels. Past
experience suggests there is significant potential for
The deal does not restrict output from U.S. shale producers,
who are likely to respond to higher prices by increasing their
The number of rigs drilling for oil in the United States has
already risen by 182 or 58 percent since hitting a low at the
end of May.
And OPEC's agreement leaves strife-torn Nigeria and Libya
free to increase their production if they can re-establish
security around oil installations.
For now, however, most traders seem convinced the market
will rebalance with a big drawdown in crude stocks, but from the
second half of 2017.
Brent futures prices continue to trade in a wide contango
during the first six months of 2017, signalling that traders
think stocks will remain high.
But the contango has vanished for the second half of the
year and futures prices in 2018 are now trading in
backwardation, suggesting most traders think stocks will be
falling by then (tmsnrt.rs/2hm4zT1).
(Editing by David Evans)