Oil rallies as hedge funds are caught short

Oil rallies as hedge funds are caught short
Updated 12 May 2015

Oil rallies as hedge funds are caught short

Oil rallies as hedge funds are caught short

LONDON: Oil’s sharp rally since the middle of March has been driven by a race among bearish hedge funds to cover loss-making short positions rather than any great bullishness about the outlook.
On the eve of the rally, hedge funds and other money managers had amassed record short positions in WTI-linked futures and options amounting to 209 million barrels of oil.
But in the seven weeks between March 17 and May 5, hedge funds cut their shorts by almost 116 million barrels to 93 million, a decline of more than 55 percent.
Over the same period, hedge funds added only 7 million barrels of net new longs, a 2 percent increase from 381 million to 388 million, according to the US Commodity Futures Trading Commission (CFTC).
Hedge fund short covering coincides almost precisely with the rise in front-month WTI prices, from a recent low of $42 per barrel on March 18 to a high of more than $62.50 on May 6, an increase of nearly 50 percent.
The spread between the price of WTI delivered in June and December 2015 has halved from $6.16 to $3.08 between the same dates, and since tightened further to just $2.71.
Now the record short has been largely squared up, the rally has faded, as there are fewer short positions to buy back.
The snapback has been a classic case of the speculative community getting it wrong — amassing a record short position and betting heavily prices would continue falling even when prices were already very low.
It is the mirror image of what happened in May and June 2014 — when the speculative community amassed a record WTI long position of 451 million barrels betting on a further rise when prices were already very high and about to crash.
Rather than betting against the trend and assuming prices will tend to revert toward the mean, a significant number of funds are assuming trends will persist and extend.
Investors often follow the maxim that “the trend is your friend” but in the oil market over the last 12 months it has proved a fickle one and cost some hedge funds heavily.
For the producers, Saudi Arabia and OPEC have both blamed speculators for some of the wild swings in oil prices during 2014 and 2015.
Earlier this year, hedge funds came under fire for propping up oil prices at unrealistically high levels before the crash by over-estimating “geopolitical risks” to oil supplies.
Since that point, OPEC officials have blamed speculators for driving prices excessively low by ignoring evidence that shale production was tapering.
The OPEC position overstates the role speculators have played.
There have been sound fundamental reasons for the crash and partial rebound in prices over the last 12 months.
But there is no doubt the huge turn round in speculator positions, from record long in June 2014 to record short in March 2015, accelerated and exaggerated the movement in prices.

— John Kemp is a Reuters market analyst. The views expressed are his own