As U.S. crude wobbles near $40, new oil rally in doubt

Oil stocks.

*Oil stocks.

04 August 2016, London — U.S. crude’s slide below $40 a barrel this week has hardened the resolve of oil market bears to drive prices lower, with oversupply, refining cutbacks and a breakdown in the oil/dollar trade spelling an end to this year’s rally.

Few believe oil will revisit the 12-year lows of $26 to $27 a barrel seen in the first quarter, but many are zeroing in on $35 a barrel or lower for U.S. crude. Short bets have increased in recent weeks as investors believe the spring rally that nearly doubled the price of oil took the market too far, too fast.

“The bandwagon trade just two months ago was that we will hit $60, but now $35 is looking like more of a reality,” said John Kilduff, a partner at New York energy hedge fund Again Capital.

“We’re in a vicious cycle, with no sign of this glut in oil products disappearing anytime soon, while any cutback by refiners is backing up crude into the system. This tells me the rally is over,” said Kilduff. He said he was using mostly options and futures positions to bet on $35 oil.

Crude inventories jumped by 1.4 million barrels in the most recent week, surprising forecasters who expected an identical draw. The build brought stockpiles, minus the U.S. strategic reserve, to an all-time seasonal high of 522.5 million barrels, according to the U.S. Energy Department.

OPEC oil producers are pumping near record high levels while top crude exporter Saudi Arabia cut prices for its Asian customers at the weekend, signalling another price war and tussle for crude market share.

West Texas Intermediate (WTI) crude settled below $40 on Tuesday for the first time since April. It ended Wednesday at $40.83 a barrel.

Tariq Zahir, an oil bear who trades mostly in time spreads of WTI, is betting the spot U.S. price will not hold above $40 for long.

“I’m selling into this rally,” Zahir, who heads Tyche Capital Advisors in New York, said Wednesday. Having frequently made money this year betting nearer-dated oil contracts will weaken against farther-dated deliveries, Zahir was also emboldened by short bets that have built up lately against WTI.

Speculators, including hedge funds, have turned increasingly bearish toward crude and refined products in the last two months, adding the equivalent of 56 million barrels of extra short positions in the three main Brent and WTI futures and options contracts in the week ending July 26.

Oil’s recent tumble came amid a breakdown in its correlation with the dollar .DXY. When the dollar falls, oil usually rises. That did not happen earlier this week when the U.S. currency fell to six-week lows. Some saw that as a bearish sign.

Yet others expect stronger oil prices. Goldman Sachs on Wednesday maintained its 2017 target for oil at $52.50. The bank noted that most of the sell-off has been the result of declines in far-dated contracts, suggesting a “repricing of long-term potential supply,” rather than a reassessment of current conditions.

French bank Societe Generale said in a note on Tuesday that compared to the first quarter of the year, when global stocks were rising, now, “global supply and demand are roughly balanced, in large part due to steadily declining U.S. crude production.”

*Barani Krishnan; Editing – David Gregorio – Reuters

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