(John Kemp is a Reuters market analyst. The views expressed are
* Chart 1: tmsnrt.rs/2kiH2WU
* Chart 2: tmsnrt.rs/2jTBZgO
* Chart 3: tmsnrt.rs/2kiSP7t
* Chart 4: tmsnrt.rs/2kiGlNm
By John Kemp
LONDON, Feb 6 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
(Editing by Dale Hudson)