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Hedge Funds Uncertain Of Further Oil Price Increase

Oil Barrels

The oil rally is facing considerable resistance at the $50 per barrel levels, and hedge funds have closed 63 million barrels of long positions—a reduction of 10 percent—in the week ending 14 June. They have also gradually started to pile on short positions. In the week ending 14 June, hedge funds added 19 million barrels of short positions of the NYMEX WTI contract.

"A lot of the rally from $40 to $50 was based on the fires in Canada," said Bill O’Grady, chief market strategist at Confluence Investment Management in St. Louis, reports Bloomberg.

The Canadian wildfire removed 1.5 million barrels per day (mb/d) of supply, whereas the total global supply outage due to various other reasons was close to 3.5 mb/d. It is this disruption in supply that has put a floor beneath the oil prices.

With reports of producers resuming supply, the International Energy Agency (IEA) believes that by mid-July, the Canadian supply will return to normal.

"The biggest fundamental news in the market is that Canadian producers are restarting output," said Michael Lynch, president of Strategic Energy & Economic Research in Winchester, Massachusetts. "I’m not counting on the other disruptions ending soon but they are already priced in." Related: $1 Trillion In Spending Cuts Could Lead To An Oil Price Spike

This fundamental news along with the uncertainty of the Brexit referendum led to the largest one-week reduction in net-long positions since July 2014, according to an analysis of data published by the U.S. Commodity Futures Trading Commission and the Intercontinental Exchange, reports Reuters.

Though there is no ceasefire agreement between the Nigerian government and the Niger Delta Avengers, the efforts of the government to find one is keeping the long positions on the edge.

Goldman Sachs believes that the current rally in oil prices is “fragile”, as the supply glut will prolong once the supply outages are restored.

The likely return of U.S. oil drillers will also weigh on the long positions.

"We’re seeing that producers are responding to $50 oil at the margins," Tim Evans, an energy analyst at Citi Futures Perspective in New York said. "The number of rigs has increased for three weeks now, so it’s looking a lot more like the start of a trend and not a fluke," reports Bloomberg. Related: NASA May Have Just Transformed Aviation With 100% Electric Plane

Though the risks to the oil rally are increasing, we are yet to see a return of surplus oil supply in the markets. At best, the current situation can be termed as a balance between supply and demand, meaning that it is unlikely that we will see either a runaway rally or a sharp drop.

However, as the rally stalls, the hedge funds and the large traders are likely to book profits on their long positions and wait for a better entry point or a change in the fundamentals. The short positions are more about testing the waters, expecting a pullback of the rally from the lows to the recent highs.

The shift in position is an indication that the easy money on the long side has already been made, henceforth, any rise will face selling at every higher level. Hence, any new positions should only be formed after careful analysis, with an eye on which side the fundamentals are going to tip over.

By Rakesh Upadhyay for Oilprice.com

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