The mood in the crude oil and oil product futures market turned decisively sour in the fourth quarter of 2018 as building crude oil oversupply and signs of slowing global economic growth rate hit investor sentiment.
Hedge funds and other money managers liquidated a lot of bullish positions in crude oil and in middle distillates in October, November, and December.
By the end of 2018, the net long position—the difference between bets that prices will rise and bets on a drop—in U.S. diesel futures had flipped to a net short position, where bets on a drop prevail over bets on price increases.
The overall bearish position in diesel is consistent with the market behavior before and during economic slowdowns or recessions in the past two to three decades, Reuters market analyst John Kemp argues.
Middle distillates—such as diesel, jet fuel, and gasoil—are more closely associated with economic cycles than, say, gasoline, because diesel and the other middle distillates are predominantly used in manufacturing, mining, farming, and freight transportation.
The bearish position on diesel futures could be a sign that money managers expect an economic slowdown or even a recession.
Money managers began last year holding a record net long position in U.S. diesel—equivalent to 64 million barrels, according to data from exchanges compiled by Kemp.
By the beginning of October, the net long position in diesel was still equivalent to 48 million barrels, pointing to the money managers’ expectation that the economy would continue to expand at a steady pace.
But by the end of November, the net long position in diesel vanished. By the middle of December 2018, the overall bullish position had already turned into a net short position equivalent to 8 million barrels, according to the latest data crunched by Kemp.
The soured mood in the market coincided with a 40-percent slump in WTI Crude and Brent Crudebetween early October and end-December, when market participants started to worry that a global economic slowdown would hit manufacturing and trade, and by extension, oil demand growth this year.
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Just last week, the World Bank said it expects oil prices to average $67 a barrel this year and next, down $2 compared to projections from June last year. In its Global Economic Prospects report, the World Bank also revised down its global growth projections amid “darkening skies” for the global economy.
The World Bank now sees global economic growth slowing down to 2.9 percent in 2019 from 3 percent in 2018, as international trade and investment weaken.
“The outlook for the global economy has darkened. Global financing conditions have tightened, industrial production has moderated, trade tensions have intensified, and some large emerging market and developing economies have experienced significant financial market stress,” the World Bank said last week.
Also last week, Fed chairman Jerome Powell said that the “U.S. economy is solid,” and the principal fear would be global growth which is somewhat slowing.
“The question would be how much does that affect us,” the Fed’s chair said at the Economic Club of Washington, D.C.
In the first two weeks of 2019, oil prices rallied on hopes that the U.S.-China trade talks could bridge some gaps in their differences. The start of the OPEC/non-OPEC production cuts and Saudi Arabia’s continued pledge to cut exports and basically “do whatever it takes” to balance the market also supported oil prices which returned into a bull market last week.
Powell’s comments that the bank would be “patient” and watch carefully how the U.S. economy evolves this year before deciding on more interest rate hikes, also helped to sustain oil prices last week.
Going forward, money managers and all market participants and analysts will be closely watching the signs about the pace of global economic growth to try to guesstimate the rate of global oil demand growth in 2019.