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Are Oil Prices About To Bounce Back?

Tsvetana Paraskova

Spooked by gloomy outlooks for the global economy and oil demand growth, money managers continue to amass shorts and cut longs in oil.  

Hedge funds and other portfolio managers cut their net long position—the difference between bullish and bearish bets—in the six most important petroleum futures contracts by 96 million barrels in the latest reporting week to June 11, according to exchange data compiled by Reuters columnist John Kemp.  

Hedge funds cut longs by 54 million barrels, while they added 42 million barrels of shorts in the petroleum contracts in the week to June 11, accelerating the sell-off in the past seven weeks to 396 million barrels. In the 15 weeks before that, money managers had boosted long positions by 609 million barrels, the data compiled by Kemp shows.  

As of the end of April, hedge funds were holding long positions in Brent Crude and WTI Crude that outnumbered shorts in a ratio of 11:1—the most lopsided bullish positioning since October 2018, when oil prices started crashing to lose 40 percent until the end of 2018.

As the month of May progressed, portfolio managers started to cut their net long position, although the reduction was almost exclusively due to liquidation of bets that prices will rise, not the opening of fresh short positions that prices will drop. Longs on crude oil still outnumbered shorts by a ratio of 7:1 as of May 21.

At the end of May and early June, however, the oil market turned decisively bearish as fears of slowing global economy and oil demand growth intensified. Analysts began to warn that this year’s oil demand growth could be the lowest in years and speculators started to intensify the sell-off in the petroleum complex.

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The ratio of long to short positions in Brent Crude and WTI Crude dropped to 3:1 in the week to June 11, down from the 11:1 high at the end of April.

In the latest reporting week, most of the sell-off in oil was concentrated in WTI Crude, where shorts jumped by 46 percent, leaving the net long position at its the smallest since February this year, as continuously growing U.S. production and builds in U.S. crude inventories added to the bearish sentiment.  

This hedge fund positioning took place before the apparent attack on oil tankers in the Gulf of Oman in the Middle East last Thursday, which sent oil prices surging, for just one day.

Not even the highest tension in the region in years was able to push up oil prices as demand-side concerns are currently outweighing fears of a significant supply outage.  

While speculators are weighing fears of a supply crunch against concerns about slowing oil demand growth, the hedge fund positioning may result in a short squeeze, Reuters’ Kemp argues, if demand fears turn out to be overblown and the global economy regains a healthy growth pace.

If the economy regains ground, the oil demand outlook could improve.

But currently, in the absence of any material progress in the U.S.-China trade conflict, the outlook for oil demand is uncertain at best.

OPEC said in its Monthly Oil Market Report (MOMR) last week that it expects global oil demand growth at 1.14 million bpd in 2019, down by 70,000 bpd from the previous month’s forecast, reflecting sluggish oil demand data in the developed economies in Q1.

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“Throughout the first half of this year, ongoing global trade tensions have escalated, threatening to spill over, and geo-political risks remained in many key regions. This has resulted in a slowdown in global economic activities, and weaker growth in global oil demand, both compared to a year earlier,” OPEC said, noting that “the observed slowdown in the global economy in 1H19 will further be challenged in 2H19, mainly by mounting trade disputes, with the impact on oil demand growth remaining uncertain.”

The International Energy Agency (IEA) also cut its oil demand growth forecast last week—by 100,000 bpd from last month to a current estimate of 1.2 million bpd growth for 2019—a second consecutive downward revision in its monthly reports.  

The IEA warned that world trade growth has slumped to its slowest rate since the 2008/09 financial crisis and the consequences for oil demand are becoming apparent. Demand growth in Q1 was just 300,000 bpd compared to a strong Q1 2018, and the lowest growth for any quarter since Q4 2011. The IEA, however, had some reassuring words for the oil bulls, saying that “For now though, there is optimism that the latter part of this year and next year will see an improved economic picture.”

If the global economy dodges a severe slowdown, the outlook on oil demand could improve and lead to renewed bullishness on oil by hedge funds.  

By Tsvetana Paraskova for Oilprice.com

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