26 June 2017, London — “All hope abandon, ye who enter here,” is the warning inscribed above the gate of Hell, according to the Italian poet Dante Aligheri (“The Divine Comedy”, Inferno, Canto III, 1308-1320).
Hedge funds and other money managers appear to have entered their own special version of hell and abandoned all hope that OPEC will rebalance the oil market, slashing formerly bullish bets on crude futures and options.
Hedge fund managers cut their net long position in the three main futures and options contracts linked to Brent and WTI by 109 million barrels in the week to June 20.
Funds have cut their net long position by a total of 161 million barrels over the last three weeks, taking it down to just 389 million barrels, the lowest since Aug. 9, 2016.
Fund managers now hold just two long positions for everyone short position, which ranks among the most bearish positions since oil prices started to tumble in the middle of 2014.
Extreme bearishness extends to refined fuels, where hedge funds have a net short position of 27 million barrels of U.S. heating oil and a near-record net short position in U.S. gasoline of 21 million barrels.
The hedge fund community placed enormous faith in OPEC’s ability to accelerate oil market rebalancing through cuts announced late in 2016 in association with key non-OPEC producers.
Fund managers accumulated a record net long position of almost 1 billion barrels by the middle of February only to suffer a sharp reversal in prices starting early the next month.
The accumulation of long positions for a second time in April was similarly rewarded with a brutal sell-off in oil prices, leaving many fund managers struggling with large losses for the year.
OPEC’s decision to leave production unchanged last month, rather than cut more deeply, has sparked a third sell off, and extinguished any remaining bullishness and emboldened short sellers.
Hedge funds have embarked on a new cycle of short-selling in Brent and WTI, the eighth since the start of 2015, which has added to the downward pressure on prices.
Fund managers have added 77 million barrels of extra short positions in WTI and 59 million barrels in Brent since June 6, according to data from regulators and exchanges.
Hedge funds have added short positions faster and more aggressively than during any previous short-selling cycle in the last three years.
Short positions across the three major Brent and WTI contracts are now running at the highest level since August 2016 and close to the record short position established in January 2016, just as oil prices reached their lowest point in this cycle.
But the extreme pessimism across the entire petroleum complex is raising the risk of a reversal and future rise in prices (just as it did in January 2016).
The concentration of short positioning in Brent and WTI is becoming a crowded trade and threatens to spark a rise in prices if and when fund managers try to lock in profits and cover some of those positions.
The fundamental outlook appears weak, with U.S. shale drillers continuing to add extra rigs, despite the downturn in prices, but positioning data shows the risk of a short-covering rally is increasing.
*John Kemp, Editing: Susan Thomas – Reuters