Money managers are overwhelmingly betting that oil prices will continue to rise in the short term as geopolitical wild cards trump concerns that U.S. shale and other non-OPEC supply growth could offset part of OPEC’s efforts to further tighten the oil market.
The longs to shorts ratio in the six major petroleum contracts rose to record highs last week—a sign that hedge funds and other portfolio managers are certain that the direction for oil prices in the coming weeks is up.
In addition, over the past two weeks, options traders have boosted their bets on Brent rising to $80 a barrel, and calls on Brent at $80 is the most crowded options trade on the ICE Futures Europe exchange, followed by call options on Brent at $70 a distant second. Options traders hold nearly 137 million barrels worth of $80 Brent call options, a 37-percent jump from two weeks ago, Bloomberg reports.
In the six most important petroleum contracts, money managers held long to short positions in a ratio of nearly 14:1 last week, compared to a 12:1 ratio at January 23, when portfolio managers held the record net long position in oil — 1.484 billion barrels, according to regulators and exchanges data compiled by Reuters market analyst John Kemp.
For the week to April 20, money managers held a net long position of 1.411 billion barrels of Brent, NYMEX and ICE WTI, U.S. gasoline, U.S. heating oil, and European gasoil—close to the record net long position from January.
In Brent and WTI only, money managers held last week the most lopsided position ever, with 15 longs for every short. Hedge funds’ ratio of long to short positions in Brent and WTI jumped to 15:1 from 13.2:1 the prior week, Kemp has calculated using exchanges and regulators data.
While this extremely lopsided long-short position could lead to a violent correction if and when fund managers start to liquidate some of the longs, analysts (and apparently money managers) see geopolitical risks as the key driver of oil prices in the coming weeks.
“For oil prices, the path of least resistance remains higher. Who wants to short the market in size in the current geopolitical climate?” Thibaut Remoundos, founder of Commodities Trading Corporation, which advises on hedging strategies, tells Bloomberg.
The current geopolitical climate has many wild cards.
Venezuela is collapsing and the only unknown here is how low its oil production will further plunge—and how fast it will do so. The country is holding a presidential election on May 20, which the U.S. and several Latin American nations say they will not recognize. New sanctions on Venezuela could follow, including a possible ban on U.S. light oil exports that Venezuela uses to blend its heavy oil to move it through pipelines. Even without sanctions on its oil industry, Venezuela will continue to lose dozens of thousands of barrels per day of oil production each month, analysts say.
Iran is another wild card—May 12 is the deadline for U.S. President Donald Trump to decide whether to waive sanctions on Iran as part of the nuclear deal. Analysts diverge on the probability of re-imposition of sanctions on Iran, the actual impact on Iranian oil exports, and whether a potential loss of Iranian oil barrels has already been priced in.
Yet, this is a wild card looming over the oil market, and it’s one of several in the Middle East, with possible escalation of the conflicts in Syria and Yemen also adding to the geopolitical premium risk.
This quarter, and particularly the month of May, has a lot of geopolitical supply risks, including in the Middle East, North Africa, West Africa, and Latin America, according to Eric Lee, a Citi energy strategist. If supply risks materialize, money managers—with their near-record longs—may be well-positioned for the upside, but if a bearish catalyst kicks in, there could be sharp moves down, Lee told Bloomberg.
OPEC’s drive to push up oil prices and keep them high creates a pressure that in 2019 supply growth could be much more than anticipated, Lee noted.
OPEC’s de facto leader Saudi Arabia “is going to the whip to try to get prices higher”, John Kilduff, founding partner at Again Capital, told CNBC last week, commenting on the reports that the Saudis are pushing for oil at $80-100. Saudi Arabia is capitalizing on their own production restraint, help from other non-OPEC producers, robust global demand, and a “total mess” in Venezuela, according Kilduff.
“Now the Saudis are really again going for the jugular here and trying to goose the price higher,” the strategist said, warning that higher oil prices will not only spur more U.S. shale that will hedge to lock in much higher prices, but will also incentivize deepwater U.S. and deepwater Brazil, for example.
Although geopolitical risks and bullish oil demand growth projections currently outweigh bearish factors, if money managers start to exit the extremely overstretched longs, the rally could come to an abrupt end.