Hedge Funds Gamble for a Third Time on Oil Rebalancing
"If at first you don't succeed, try, try, try again," goes the proverb used to encourage students.
Hedge fund managers are becoming bullish towards crude oil and refined fuels for the third time this year and must be hoping the signs of market rebalancing are real this time after early setbacks proved costly.
Hedge funds and other money managers raised their net long position in the three major futures and options contracts linked to Brent and West Texas Intermediate (WTI) to 705 million barrels in the week to Aug. 8.
Fund managers have boosted their net long position in Brent and WTI by the equivalent of 347 million barrels over the six weeks since June 27, according to regulatory and exchange data.
Managers have nearly doubled their net long position in crude since the end of June and now have the largest net position since April.
Long positions outnumber their short positions by a ratio of 5.19:1, up from a recent low of just 1.95:1 on June 27, displaying a pronounced bullish bias.
But in the most recent week, the extra net length all came from the ICE Brent contract, where long positions were increased by 40 million barrels while short positions were trimmed by 19 million.
By contrast, net positions in NYMEX and ICE WTI were little changed, with long positions trimmed by 2 million barrels and short positions actually up by 1 million.
Increased net length in Brent is likely connected to a sudden tightening of the calendar spreads, which has seen Brent move from contango into backwardation between October and December 2017 (V7-Z7).
More generally, Brent calendar spreads have tightened much more than WTI since the last week of July, which has made Brent more profitable for hedge fund managers with long positions.
Increased bullishness towards crude has also been mirrored in hedge fund positions for U.S. gasoline and heating oil.
Hedge funds raised their net long position in gasoline by 2 million barrels to 47 million barrels in the week to Aug. 8. Fund managers are now more bullish on gasoline prices than at any time since the middle of February.
Portfolio managers also raised their net long position in U.S. heating oil by 6 million barrels to almost 25 million barrels.
Positioning in heating oil is only slightly less bullish than on gasoline, with net length the highest since April and the long/short ratio the highest since February.
Third Time Lucky?
Fund managers have become bullish about the outlook for crude and fuels prices twice this year already, in January/February and then again in April.
Fund managers have become bullish about the outlook for crude and fuels prices twice this year already, in January/February and then again in April.
On both occasions, hopes for a rapid and sustained rebalancing of the oil market turned to dust, and fund managers incurred large losses when prices subsequently fell back.
Losses from oil have forced the closure of a number of commodity-focused hedge funds already this year.
Now the remaining fund managers are hoping they will be lucky third time around. But so far most are being very cautious about building new long positions.
Most of the adjustment in the five major petroleum contracts has come from a reduction in short positions rather than the creation of new long positions.
Total short positions across the five major crude and fuels contracts have been reduced by 288 million barrels since June 27, while long positions have risen by only 184 million barrels over the same period.
Hedge funds’ short positions in crude, gasoline and heating oil have been cut from a record 510 million barrels near the end of June to just 222 million barrels on Aug. 8.
Most short positions have now been closed, so short-covering is likely to provide less of an impetus for rising prices in the short term.
There is scope to add more long positions, if a convincing narrative can be constructed, with longs across the five major contracts about 160 million barrels lower than in February.
But bullish hedge fund managers are now relying on a continued drawdown in petroleum stocks, a stabilisation of the U.S. rig count and optimism about market rebalancing to continue moving prices higher.
By John Kemp