The professional money managers covered 25,639 short contracts for crude oil last week—the highest figure in the past 11 months.
These large short squeezes are indicative of bottom formations, which are driving the first leg of this new trend. However, sustenance depends on fresh buying, so a short squeeze will only propel the markets so far.
We expect fresh buying to step in closer to $32 per barrel.
A similar bout of short covering occurred in March and April 2015, pushing oil prices up from $42 per barrel to $62 per barrel, only to turn back and drop to a low of $26.03 per barrel. This led many to believe that the current rise in short coverings is another such event—a belief that may trap buyers.
This time, the situation is very different.
1. The shale oil producers were still unhurt in 2015, as many enjoyed high prices due to hedging at higher levels. However, most hedges expired at the end of 2015 and early 2016, and experts believe shale oil production will drop in 2016. The EIA is forecasting a reduction of 106,000 for April 2016.
2. The Baker Hughes Oil Rig Count has dropped 57 percent from 922 on March 2015 to 392 on March 2016. The steady drop in oil rig count led Morgan Stanley's Ole Slorer to note that at the current rate, the oil rig count will be zero by August, as reported by Business Insider.
3. The International Energy Agency forecasts a drop in global oil demand growth from 1.6mb/d in 2015 to 1.2 mb/d in 2016. The world will still need more oil compared to last year, but the non-OPEC production of oil is likely to reduce by 0.6 million b/d and OPEC production by 0.1 million b/d, according to the U.S. Energy Information Administration. This increased demand and decreased supply will help reduce the supply glut, though some excess supply will still remain.
4. The sharp fall in prices has reduced global oil and gas investments by 22 percent compared to 2015 and is expected to be at the lowest level in the last six years, according to the Oslo-based consultancy Rystad Energy, as reported by Reuters. Bjoernar Tonhaugen, vice president of oil and gas markets at Rystad Energy said: "This will be the first time since the 1986 oil price downturn that we see two consecutive years of a decline in investments." The drop in investments will lead to a production slowdown in the future.
5. Iran is facing hurdles in ramping up production to the extent it had forecast; it’s lagging behind and will likely continue to do so according to the experts, as reported by Bloomberg.
6. The mid-March meeting between Russia and OPEC is an important event, because major oil producing nations, barring the U.S., are a part of it. If the meeting arrives at a consensus and ends without bickering among the participating members, it will put a floor underneath the market. When fierce competitors sit together for a meeting to support oil prices, it indicates that the pain from low oil prices is becoming unbearable. If prices were to drop again, it’s not impossible that the participating members will arrive at an agreement to support prices.
This does not mean that oil will see a one-way move from here on. The famous adage--buy the rumour and sell the news--will again come into play post-meeting, and oil will again fall from the current levels.
However, buying should soon emerge closer to the technical Fibonacci level of 50 percent retracement, and oil should enter a trading range until the demand-supply situation is sorted out.
By Rakesh Upadhyay for Oilprice.com
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