(John Kemp is a Reuters market analyst. The views expressed are
* Chart 1: tmsnrt.rs/2kngV0S
* Chart 2: tmsnrt.rs/2knkuEp
By John Kemp
LONDON, Feb 7 Hedge funds have accumulated a
large net long position in crude oil futures and options but the
size of the position and its implications for future movements
in prices are disputed.
Hedge funds and other money managers had accumulated a net
long position in the three main futures and options contracts
linked to Brent and West Texas Intermediate (WTI) equivalent to
885 million barrels by Jan. 31.
The combined position had a notional value of $48 billion at
prevailing prices, according to an analysis of records published
by regulators and exchanges.
Measured in barrels, the net long position is at record
levels, comfortably exceeding the net long position of 626
million barrels hedge funds had amassed in June 2014, before
In terms of notional value, however, the position is well
below the $68 billion exposure hedge funds held in 2014 (tmsnrt.rs/2kngV0S).
The slump in oil prices means hedge funds can now hold twice
as many barrels for the same amount of notional value.
So the combined hedge fund position in Brent and WTI looks
very stretched in barrel terms but less so in dollar terms.
Both approaches to measuring positions have strengths and
weaknesses; it is not clear which is a more relevant indicator.
A more useful measure of hedge fund positioning and its
impact on prices is the ratio of long and short positions.
The ratio is a dimensionless quantity without any physical
or financial units because the barrels or dollars cancel each
So it provides some insight into how bullish or bearish
money managers are in aggregate and is unaffected whether the
price of oil is $50 or $100 per barrel.
Hedge funds do not determine the level of oil prices and
have only a partial influence on the direction of price
movements over the short and medium term.
But the short-term rise and fall in WTI prices has been
somewhat correlated with the accumulation and liquidation of
hedge fund long and short positions since 2010.
An increasing long-short ratio has typically been associated
with a rise in WTI prices while a decreasing long-short ratio
has generally been associated with a fall in WTI (tmsnrt.rs/2knkuEp).
In WTI, for which there is a longer time series, the ratio
of long to short positions has been cyclical, with an irregular
magnitude, and subject to sharp reversals.
The long-short ratio currently stands at 9:1, a substantial
increase since the ratio of 2:1 in the middle of November 2016,
before members of the Organization of the Petroleum Exporting
Countries reached their output deal.
Hedge fund managers have become increasingly bullish about
OPEC’s ability to drain excess inventories and push oil prices
higher, or at least to establish a price floor.
As a result, the ratio is the highest since July 2014, when
oil prices had just started to fall and were still above $100
But it is well below the ratios of 18:1 and 17:1 reported
briefly in June 2014 and February 2014 respectively or the
record 22:1 reported momentarily in February 2012.
None of these very high long-short ratios was sustained for
more than a week or two and they were all followed by a sharp
downward correction in the ratio and prices.
The ratio of 9:1 in the week to Jan. 31 was in the 86th
percentile for all weeks since the start of 2007, so it was
There is some scope for the ratio to become even higher in
the short term if funds continue adding to long positions or cut
their already low short positions further.
But with the ratio already looking stretched, there is an
increasing probability it will reverse, as hedge funds pare long
positions and/or increase the number of short positions.
IMPACT ON PRICES
How much impact that would have on WTI prices is unclear.
The accumulation of hedge fund long positions has had only a
relatively modest impact on prices since the middle of December.
Liquidity has been high in the last seven weeks. Fund
managers have found plenty of willing sellers, especially among
producers and traders, eager to take the short side of their
If liquidity remains high, fund managers may find plenty of
willing buyers when they try to reduce their net long position,
with only a modest correction in prices.
But if liquidity evaporates, funds may initiate a sharper
correction of prices when they try to close out some of their
long positions and open new short ones.
(Editing by Dale Hudson)