(John Kemp is a Reuters market analyst. The views expressed are
* Chart 1: tmsnrt.rs/2pg4KmJ
* Chart 2: tmsnrt.rs/2pHfjBV
By John Kemp
LONDON, May 5 Oil traders have finally given up
on an early rebalancing of the crude market, with flat prices
and calendar spreads plunging to the lowest level since OPEC’s
agreement was announced.
OPEC has lost control of the oil market narrative, after
successfully shaping it in an informal alliance with hedge funds
in the last part of 2016 and the first few months of 2017.
Controlling the narrative provides an important source of
short-term influence over prices (“Narrative economics”,
Presidential Address to the American Economic Association,
Senior OPEC and non-OPEC officials have dropped strong hints
that current production cuts will be extended for a further six
months, but oil traders seem increasingly sceptical about the
effectiveness of prolonging the curbs until the end of 2017.
Brent prices for the futures contract nearest delivery
closed at $48.38 per barrel on Thursday, the lowest since Nov.
29, the day before OPEC’s last meeting (tmsnrt.rs/2pg4KmJ).
Brent calendar spreads for the six months from July 2017 to
January 2018 fell to $1.19 contango, which was also the lowest
since Nov. 29 (tmsnrt.rs/2pHfjBV).
The informal understanding on market rebalancing between
OPEC and some of the most important hedge funds reached late
last year finally unravelled this week.
OPEC committed to implement credible and transparent
production cuts and to reduce global crude stocks while hedge
funds responded by establishing long positions in both flat
prices and calendar spreads.
The initial results from the understanding were positive for
both sides, with hedge funds establishing a record bullish
position in crude by the middle of February and futures prices
Brent’s flat price rose by around $10 per barrel, or more
than 20 percent, and the market structure swung from contango
But flat prices and spreads have been progressively
softening since the second half of February (“Hedge fund
confidence in OPEC starts to fray”, Reuters, April 20).
Global crude inventories have not fallen as fast as OPEC or
the hedge funds anticipated, putting the understanding under
Market expectations for a normalisation of crude stockpiles
have been pushed back from the first half of 2017 to the second
half or even into 2018.
The gradual weakening of both flat prices and calendar
spreads in recent weeks has inflicted substantial losses for
many bullish hedge fund managers.
In the last two to three weeks, many bullish hedge funds
seem to have finally given up waiting for a short-term
turnaround and decided to cut their losses (“Hedge funds lose
faith in OPEC”, Reuters, May 2).
Hedge funds cut their overall bullish position in futures
and options linked to Brent and WTI by 139 million barrels in
the week to April 25, according to positioning data published by
regulators and exchanges.
The draw down was among the largest on record but still left
the hedge funds with a relatively large overall bullish position
equivalent to 643 million barrels on April 25.
The continued fall in prices since then, and the rout on
Thursday, suggest the draw down has continued, though the full
extent will not be revealed until the new position is published
over the next 10 days.
Falling prices and the confirmed break down through previous
support levels around $50 also likely encouraged fresh short
selling by hedge funds pursuing momentum-based strategies.
Turnover in front-month Brent futures hit a record 542
million barrels on Thursday which is consistent with heavy long
liquidation and fresh short sales as well as lots of short-term
computer-driven trading activity.
The liquidation of so many speculative long positions and
establishment of fresh short ones should eventually help
stabilise crude prices.
From a positioning perspective, the balance of risks for oil
prices now looks more even than it has for some time, given the
squaring up of the large hedge fund overall long position.
The outlook may even have become slightly positive given the
large number of short positions likely to be have been
established in recent days which will have to be bought back at
Oil prices may bounce on their own. But if they do not, the
challenge OPEC and non-OPEC producers heading into another
meeting on May 25 is how to wrest control of the narrative back
from the short-sellers.
(Editing by Edmund Blair)