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Will OPEC Raise Oil Output By Itself Or Let Hedge Funds Crash The Market?

Published 04/12/2019, 04:07 AM
Updated 09/02/2020, 02:05 AM

Once again, OPEC is cutting production in shocking style, and again hedge funds are responding by pushing oil prices to higher levels each week.

And once again, the seeds to the next crude market destruction are possibly being planted without many realizing it, until the implosion catches everyone by surprise.

Brent Daily Chart

The clearest signs that it could be time to pull the brakes on the oil rally emerged on Thursday from a couple of Reuters reports and a warning by the Paris-based International Energy Agency (IEA) that suggested prices at above $70 per barrel may be unsustainable for now.

Of the two Reuters reports, one said the 14-member OPEC, and its ten other oil-producing allies led by Russia, may have to stop their output cuts by July if Venezuelan and Iranian supply keeps dropping and prices continue rallying.

Market Could Over-Tighten If OPEC Doesn’t Raise Output

This is because extending production in such a situation could over-tighten the market, the Reuters report said.

Quoting an OPEC source, Reuters said:

“If there was a big drop in supply and oil went up to $85, that’s something we don’t want to see, so we may have to increase output.”

Meanwhile, the IEA stressed in its monthly report for April that demand was a “very important” piece of the equation for oil market rebalancing and the less-than-stellar outlook for the global economy posed much uncertainty to that now.

Mixed Signals On Health Of Global Economy, IEA Warns

Elaborating, the agency said:

“As far as 2019 is concerned, amongst the analyst community there is an extraordinarily wide divergence of views as to how strong growth will be.”

“We maintain our forecast of 1.4 million barrels per day, but accept that there are mixed signals about the health of the global economy, and differing views about the likely level of oil prices.”

U.S. West Texas Intermediate crude and U.K.-traded global oil benchmark Brent fell more than 1% each on Thursday, posting their sharpest one-day retreat in three weeks on those cautions.

But barely 24 hours later, oil prices were up again, with traders chanting the mantra of cuts by the so-called OPEC+ group.

The manner in which fund managers are bidding up oil at any opportunity now is reminiscent of the events of 2014 before the first shale-driven market crash, warned Reuters oil columnist John Kemp in another article on Thursday.

He wrote that, then as now, expanding U.S. sanctions and other unplanned disruptions, such as strife in Libya, were key to pushing “prices higher in the short term and setting the stage for the next slump”.

Many Similarities Between Now And Pre-2014 Crash

Kemp presented startlingly similar situations in this year’s oil market versus five years back to show the potentially perilous path in which the trade was headed.

Kemp wrote:

“In 2013/14, U.S. sanctions on Iran, as well temporary disruptions - some actual, others threatened - caused by fighting in Libya and the advance of Islamist fighters across northern Iraq helped keep prices well above $100 per barrel.”

“Saudi Arabia and other OPEC members with spare capacity were slow to respond, insisting the market remained adequately supplied and prices were not too high.”

“But hedge funds and other money managers boosted their bullish net long position in crude futures and options to 626 million barrels in late June 2014, up from 367 million six months earlier, accelerating the price increase.”

“And production problems and high prices fuelled the final stages of the first frenzied U.S. shale drilling boom, causing output to surge, while dampening consumption growth.”

Kemp’s warning may be prescient as U.S. crude production has hit all-time highs of 12.2 million barrels after a pickup in drilling activity, which had slowed since February.

Buying Mania Counterintuitive To Oil

Scott Shelton, energy futures broker at ICAP in Durham, N.C., cited various reasons on Thursday as to why the current buying mania by oil-focused Commodity Trading Advisors, or hedge funds, was counterintuitive, particularly to U.S. crude.

Said Shelton:

"I see a market that isn’t short any more with CTA longs, and index-length now nearly 100% in the front-end of WTI.”

“There are a lot signals here to me that the market may be ready to retrace, not only on WTI spreads but also on flat price."

He added:

"I don’t want to discount that as it can take the market ‘out of value’ as it did late last year when prices went under $50 and ended up at $42. The only exception is that the fall at the end of the year was during the holidays, which means risk taking was at a minimum."

Time To Sell When Wall Street Says Buy?

Acting as cheerleaders to the current oil rally, Wall Street banks led by Goldman Sachs (NYSE:GS) have been raising their price forecasts for crude in recent weeks, focusing on tight supply rather than the economic conditions that would support the market.

Last year, several banks called for $100 oil as Brent neared $90. Suddenly, the market reversed on unexpected sanction waivers on Iranian oil approved by President Donald Trump. WTI crashed 40% in the fourth quarter, hitting a low of $42.36 on Dec. 24 before finishing 2018 at $45.10.

Ignoring the IEA's less-than-optimistic demand outlook now, RBC Capital on Thursday predicted $80 Brent by summer, warning that "many wounded bulls remain following the Q4′18 washout”.

But Shelton said such optimism spun by banks was often a sign to sell.

He adds:

“No offense to bank research, but ‘tight markets’ as reason for a rally often are blamed on a reason not to be short. I always think that is more of a spread/differential trade rather than a flat price trade.”

Latest comments

Do we have any Ichimoku experts here?  I'm new to this method and found something interesting and puzzling too.. . The daily vs weekly charts look DRASTICALLY different for both WTI and Brent!. . The weekly chart shows both the Tenkan and Kijun lines BELOW the cloud and have just crossed.  Since they are below the cloud, and the Tenkan line crossed above Kijun, it suggests oil is mildly bullish but facing resistance. . . Whereas the daily chart shows both the Tenkan and Kijun lines above the cloud and facing no resistance at all.  This is extremely bullish!. . Now, I'm totally confused...
You are brave to write such an article at a time when market bulls still have clear control of the channel. I agree with your overbought logic, but I wonder how you see the huge gap and disconnect of Brent and WTI at Friday’s US market close? It seems that OPEC trading had been able to elevate WTI directly until about 2/3rds of the way through today’s session. Will this be the sort of multi week whipsaw that I am hoping for?
Thanks for the consensus, Warren. Yes, I believe at some point, the capitulation will occur though at the moment the momentum is nothing less than that of an Acela tearing through a no-stop. The funds have their own stops of course and until those are triggered, the herd would be on its ponderous charge, oblivious to counterintuitive logic.
Using selective variables in setting analogues is dubious, but fun. 2014 was more about the supply side than demand, with OPEC internal chaos running headlong into US shale production. The combination of the two factors created a massive global crude inventory, this was the reason for the price collapse, and years long stagnation. With renewed commitment to coordination, combined with FSU collusion, OPEC+ has wrested control over price from its own monster, the glut. US production has not weakened (the opposite) and this fact has likely made OPEC+ more committed to reducing the overhang in inventories, not less, especially as Majors increase their foot-print (and control) in the shale patch. Pre-2014 price spike had much to do with fundamental supply worries - peak oil - that shale oil, and the fascination with alt energy - peak demand - has destroyed as a price stimulating fear. But shale is not diverse in grade, and alt-energy is vastly over stated.
Many profound truths from you, I agree. But the fundamental premise here is that hedge funds have grabbed ahold of the price baton and are running with it, creating greater market distortion than perhaps intended by OPEC and its allies. Putin's remark this week about his discomfort with "uncontrollable price increases" in itself is a red flag that the so-called coordination to cut may not be that great anymore as the market escalates beyond Russian needs yet remains below Saudi targets. There is real danger of popular Russian discontent over high gas prices that don't get as much play as the tweets on oil that Trump sends out. All those have to factored into the mix too to reach a conclusion if OPEC+ need to pull the brakes soon on their cuts.
Current oil speculation news is slanted toward fears of uncertainty and price collapse. This media pattern is used when mega-investment firms are seeking to accumulate holdings in the Industry, at minimum cost. Thus, it is likely that higher oil prices are anticipated by those in the know, and they need small-investors "cooperation" to fill their massive quotas. Look for oil prices to mysteriously climb in the near future, accompanied by disappointment of those who reacted to the fear-mongering media, and unloaded their positions. Nothing is truly as it seems, and the comprehension of such is the basis of future profitability in todays' market.
Thank you, Mr Hiepler.. . An argument that could cut both ways as hedge funds often run ahead of the market, distorting price vs fundamentals, till the market itself becomes untenable in its current form.. . That's what this story is all about.. . Please continue reading and following us here and @Investingcom.
another reason to buy an electric car.
Why? Don't you think that there will be price distortion and manipulation on resources required to build your 'holy grail' of supposed clean energy. Wake up!
thats capitalism. But clean air in cities is a driving force, certainly in europe.
this is hyperbol. Prices in the last decade have been up to $110 and low as $25. There is not valid limit to the upside price except that it peaks according to demand.
Exactly. Price could be getting out of whack with demand is what this story tends to tell.. . The history isn't too dated either: Less than five years.
Hope this is to make the Canadian dollar weak?
Not certain about that,
opec i helpless , price is undercontrol - Libya's oil chief says renewed fighting could wipe out crude production
THAT ... could be hyperbole.
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