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Tom Kool

Tom Kool

Tom majored in International Business at Amsterdam’s Higher School of Economics, he is Oilprice.com's Head of Operations

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Naive Hedge Funds Bet Too Big On An OPEC Cut

It seems that hedge funds and money managers had built up too big a bullish position before the OPEC deal, send oil prices down when the 9-month extension was announced.

Friday, May 26, 2017

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OPEC and non-OPEC members secured a nine-month extension of their deal, pushing the combined 1.8 million barrels per day in reductions through to the first quarter of 2018. The cohesion among the disparate members was notable, although the markets, hoping for a bullish surprise, were less than impressed. After hinting at deeper cuts or perhaps an extension through the middle of 2018, oil traders were left disappointed. There is evidence that hedge funds and other money managers built up a bullish position ahead of the meeting on the off chance that OPEC would surprise the market with more aggressive action. Once that was off the table, there was a selloff in crude positions. OPEC officials shrugged off the price drop, arguing that they can’t be concerned with daily price movements.

OPEC’s cut aimed at Saudi Aramco IPO. One of the principle motivations for Saudi Arabia to keep the production cuts going is to boost the valuation of Saudi Aramco when it stages an IPO next year. The Saudi government needs higher oil prices in 2018 in order to maximize the sale of Aramco. Saudi officials allege that the company is worth some $2 trillion, although others dispute that figure. Nevertheless, the timing of the Aramco IPO ensures that Saudi Arabia will do “whatever it takes” to keep oil prices afloat.

No “exit strategy” yet for OPEC. OPEC is confident that the nine-month extension will drain inventories back to average levels by the end of the compliance period. However, some analysts have raised the prospect of a renewed glut once the deal expires. If that were to happen, OPEC might find itself in a position of having to extend the cuts indefinitely. Obviously, it does not want to do that. When asked about an “exit strategy,” Saudi energy minister Khalid al-Falih said that they did not have one, but that they would work on coming up with a plan over the next nine months.

Related: UAE Gains Edge In $165 Billion Caspian Oil & Gas Market

OPEC and non-OPEC alliance surprisingly strong, but road gets tougher from here. The compliance rate from within OPEC has been very strong, save for Iraq. Non-OPEC cuts were less impressive over the initial six-month period. Nevertheless, the display of unity in Vienna on Thursday is a sea change from the past, and the understanding between Saudi and Russian officials in particular is important. However, compliance will be much more difficult going forward, with more members achieving higher levels of production capacity. Historically, such alliances to restrain output have proven to move oil prices in the short-run, but “they eventually fall apart,” Robert McNally, president of energy consultancy the Rapidan Group, told the Wall Street Journal.

Iraq looks at hedging. Iraq is considering a hedging program to ensure it has predictability regarding oil revenues for next year. The head of Iraq’s state-owned oil marketing company said that the country is considering a plan to hedge as much as a quarter of its production. That move is likened to the strategy pursued by Mexico, which routinely locks in large volumes of crude sales a year ahead. The tricky thing about this size of a hedge is that it can actually influence futures prices. At this point, Iraq says it is only in the early stages of such a plan.

Global shipping fleet braces for fuel emissions standards. By 2020, the global shipping industry will have to begin using cleaner fuels in order to cut down on acid rain and other air pollution problems. The regulations come from the International Maritime Organization (IMO), and will affect the 90,000-ship merchant fleet around the world. The industry could spend as much as $60 billion complying with the standards, according to Wood Mackenzie. The problem is that it is uncertain where sufficient volumes of cleaner fuels will come from. The regulations could disrupt shipments and add to the cost of global trade.

China downside risk to oil prices. China’s credit rating was downgraded earlier this week by S&P, raising a red flag for oil demand. China’s economy is showing weakness and growth concerns could weigh on oil demand. "Without China, the oil market cannot survive," said Fereidun Fesharaki, founder and chairman of FGE. Still, falling domestic production could mean that oil imports rise going forward. Related: Unstoppable: U.S. Adds Oil, Gas Rigs As OPEC Extends Deal

Canada introduces methane regulations. Canadian regulators proposed new rules on methane emissions from oil and gas drilling, with an objective of cutting emissions by 40 to 45 percent below 2012 levels by 2025. The industry has said the rules would be costly while the government says the benefits will make them very achievable. Still, the industry won a reprieve as it now appears full implementation will be pushed back to 2023 from the originally proposed start date of 2020.

BNEF: Electric vehicles to beat internal combustion engine on price by 2025. New research from Bloomberg New Energy Finance concludes that EVs will be cost competitive with traditional gasoline and diesel-powered vehicles by 2025. Batteries account for about half of the cost of the EV, and battery costs are trending downward, with costs to fall by an additional 77 percent by 2030.

BlackRock investing in renewables. The world’s largest investment group is getting into renewables – which should scare coal investors. BlackRock says that renewables are not only already competitive with coal, but that looking forward, it isn’t even a close race. "Coal is dead. That's not to say all the coal plants are going to shut tomorrow. But anyone who's looking to take beyond a 10-year view on coal is gambling very significantly," global head of BlackRock’s infrastructure investment group, Jim Barry, told The Australian Financial Review.

By Tom Kool for Oilprice.com

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