In January I wrote what I called my “most important column” describing how the curve of oil futures, then in deep contango, needed to flatten in order for the oil market to show me that it had bottomed.
We’ve had that flattening of the curve, and with it what I think is a long-term bottom in crude prices. So, what happens when the crude curve flattens and why can you be a bit more confident in buying oil stocks when it does?
The reasons are mostly financial, and not fundamental at all – something that the vast majority of analysts discount, or at least rarely discuss. In understanding the macro motion of the curve, let’s take a quick look at the financial inputs that have dominated crude oil recently.
Fundamental global gluts of crude oil can be reasonably ‘blamed’ for the collapse of prices below $80 a barrel or even $50 a barrel – legitimate panic hedging from producers certainly added to the one-sided move we saw, but the fundamentally unsustainable pricing that we’ve seen for much of 2016, particularly after the 2nd failed OPEC meeting, has been much more dependent upon speculative short positions in the market, particularly from algorithmic momentum funds. We could track the speculative short positions against the price of crude almost exactly as prices dropped below $40 the first time, with long positions decreasing to their lowest levels in five years as crude dropped under $30 a barrel.