Speculators have been shorting crude oil at an unprecedented pace over the past few weeks.
That’s partly because rising production outside OPEC+ is forecast to lead to a glut of crude next year. Concerns about weak global industrial demand are also weighing on the market, as evidenced by large short bets on diesel.
But the sheer size of these positions also points to a deeper shift in the market: Bearish bets on crude oil are higher these days than when OPEC launched its price war at the start of the coronavirus pandemic.
Investors who held crude as a hedge against inflation have all but disappeared, while the bearish price outlook for next year has scared discretionary traders away from buying the dip.
Their retreat has heightened the influence of commodity trading advisors (CTAs), trend-following funds that trade primarily based on technical indicators, which have accumulated huge short positions.
“The net short position in crude oil is a big problem,” said Ilia Bouchouev, managing partner at Pentathlon Investments and a faculty member at New York University. “Several categories of market participants are operating with the most depressed sentiment right now.”
Fund managers have cut their allocation to commodities to the lowest in seven years, a Bank of America survey showed in September, as central banks shift their focus from curbing inflation to cutting interest rates to protect their economies.
The exodus has left hedge funds and other money managers hovering at the most bearish levels of any major oil contract since 2011. These investors turned net short on Brent crude for the first time this month and continue to hold a record net short position in diesel futures and options.
As CTAs increasingly dominate, these algorithm-driven traders have been blamed for exacerbating volatility in both directions at least three times in the past two months alone, causing volatile price swings.
“It’s terrifying,” said Trevor Woods, chief investment officer at Northern Trace Capital, which primarily uses discretionary trading strategies. “No one has conviction.”
Crude oil’s fundamentals are the main reason for the bearish outlook. Global inventories are expected to rise, with inventories in OECD countries set to rise to about 2.73 billion barrels in 2025, according to U.S. government estimates.
Cracks are also showing in demand for the fuel-making industry as European refineries cut processing rates and U.S. profits from making fuels such as gasoline and diesel plummet to their seasonally lowest levels since the pandemic.
Still, such extreme positioning raises the risk of a significant liquidation, and the market is not without potential bullish catalysts, such as recent supply disruptions in Libya, China's stimulus measures and aggressive rate cuts by the Federal Reserve. Meanwhile, U.S. crude oil inventories fell to their lowest since April 2022 last week.
“We remain structurally bearish, but it is unsettling how unanimous the bearish view is right now,” Macquarie analysts wrote in a note.
Several traders said the U.S. election could have broad implications for the oil market, and some discretionary traders are also wary of taking large positions ahead of the election. This has already been a tricky year for many traders, and the uncertainty has further discouraged them from buying oil in the short term.
“The crude oil market is like a ghost town,” said Northern Trace’s Woods.
Article forwarded from: Jinshi Data
