Oil speculators and a few major investment banks have suddenly turned bullish on crude prices, betting that the rally above $50 per barrel has more room to run.
"Global oil inventories (industry and government) increased by 17 million barrels to 5.618 billion barrels in 3Q16. This is the smallest build since 4Q14, confirming that inventory builds are slowing as the market comes back into balance," analysts from Bernstein Energy said according to Reuters. Wood Mackenzie predicts that the oil market will move into balance before 2016 is out.
In fact, major investors are starting to come to the same conclusion – that the worst for oil prices is over. Hedge funds and other money managers boosted net-long positions to their highest point since the oil bust began more than two years ago. As John Kemp of Reuters notes, hedge funds increased net long positions in WTI contracts by 39 million barrels to 292 million barrels for the week ending on October 11, the most since the summer of 2014. The sudden build up in net long positions consisted mostly of the liquidation of shorts – shorts fell 28 percent in the last few weeks – which corresponded with a move of oil prices above $50 per barrel.
The flip side of that trend is that now with such a buildup in net long positions and a dwindling number of shorts, there is a much greater risk of speculators snapping back in the other direction, having little room left on the upside. In other words, speculators might not be able to bid up oil prices any further, and in fact, could do just the opposite should some bearish news emerge – not the least of which could be a collapse of the OPEC talks.
Indeed, several analyst have come out and said that despite the recent rally, the buildup in bullish sentiment exposes the market to downside risk should OPEC falter. If OPEC’s November 30 meeting in Vienna “is a dud, then the market’s going to selloff,” Dimitry Dayen, senior research analyst at ClearBridge Investments, told The Wall Street Journal. David Hufton, the CEO of PVM Group, agrees. There are “lots of very important questions with no answers to date, and only six weeks to go before the next key OPEC meeting,” Hufton said from London. “If nothing concrete emerges on production control, the market will lose patience, with the risk of an end-year price bloodbath.”
The IEA’s executive director Fatih Birol is also unimpressed with the current state of the oil markets. He says that if oil prices rise because of the OPEC deal, the result could simply be to spur higher production from U.S. shale and other high cost producers, such as China. He sees oil prices at $60 per barrel sparking a rush of new shale output, with a lag of about six months. “The price level around $60 would give a strong impetus to the bulk of the current U.S. shale industry.”
In addition, he says that OPEC’s tentative deal to cut back on production could cut into global demand even further. “Higher prices may also push down the rather weak demand growth now. Currently we are about 1.2 million barrels per day…and this may be weaker,” Birol told Bloomberg TV from the Oil & Money Conference in London.
OPEC will try to thread a needle – bolstering prices just a little bit to keep them above $50 per barrel, but otherwise fighting for market share in order to keep prices from rising above $60 per barrel, at which point it could provoke competitors to come back online. “A $50, $60 oil price -- absent a supply accident -- is sufficient to develop the low-cost resources to provide increases that will be necessary over the next three to four years,” Andrew Gould, board director at Saudi Aramco, said from the London conference. The comments indicate that Saudi Aramco sees little benefit in letting oil prices rise above $60 per barrel. Kuwait’s acting oil minister echoed that sentiment, saying that the range between $50 and $60 per barrel was “logical” and “acceptable.”
To be sure, OPEC is not exactly sitting in firm control of the oil markets. But they appear intent on keeping oil between $50 and $60 per barrel for an extended period of time.
By Nick Cunningham of Oilprice.com
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