Hedge funds and money managers have snapped up bets on higher oil prices at a torrid pace, wagering that crude will rise as OPEC slashes production. The net-long positions are now at their highest level in more than two and a half years, with investors repeatedly breaking new net-long highs in the waning days of December. For the week ending on December 27, investors added more bullish positions, marking the seventh consecutive week of increases, the longest streak since early 2014.
“We have a very confident positioning here,” Tim Evans, an energy analyst at Citi Futures Perspective told Bloomberg in an interview. “There’s plenty of hope that prices are supported and move higher and very little fear that compliance will be poor and prices will drop.” WTI closed out the year above $53 per barrel and Brent ended close to $57.
But while the markets are highly optimistic about rising oil prices, they risk overplaying their hand. Net-long bets have built up to such a degree that traders have increased the danger of a snap back in the other direction. Bets on oil futures tend to go in waves, with trading patterns resembling a roller coaster. A bout of good news causes long bets to rise. Once they are overdone or the market gets slapped with some bearish news, investors liquidate long positions and scramble for the exit. Shorts then come out in full force. A run of shorts builds up until that trend also looks like it has gone too far, with the emergence of market tightness or some geopolitical risk ending the bear run.
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In other words, net-long bets could be on the crest of a wave, with the risk of a return to a more net-short market structure rising by the day. And each weekly build up in net-long positions only increases those odds. All that is needed is a spark, such as news that U.S. shale production is surging faster than expected or that OPEC is not complying with the November deal as closely as promised.
That puts the month of February in the spotlight, as that will be when the first bits of production data are published from OPEC. The data won’t paint a full picture, however, as OPEC members are only required to cut their six-month average down to the targeted levels. They are not required to cut to the full extent immediately this month. As such, the data may not reflect sharp decreases in output. That should not be taken as a sign of cheating, since they can cut deeper in subsequent months and still adhere to the deal. Nevertheless, headline figures about OPEC production exceeding the promised levels could spark a downturn in prices. Media hype and market psychology are always at play.