By John Kemp
LONDON Nov 5 Hedge funds' enthusiasm for U.S.
crude has cooled off, at least for now, as the relentless rise
in domestic shale output and the prospect of extended refinery
maintenance in the Midwest extinguishes any hope of a rebound in
U.S. oil futures to narrow the gap with Brent.
Hedge funds and other money managers cut their net long
position in WTI-related futures and options to just 154 million
barrels on Oct. 30 from 260 million on Sept. 18, according to
the U.S. Commodity Futures Trading Commission (CFTC).
Gross long positions have been trimmed by 45 million barrels
to 272 million. But the bigger change has come on the short side
of the market, where money managers have added 61 million
barrels to take their total short positions to 118 million, the
biggest concentration of bearish positions for two years.
The ratio of long positions to short ones has fallen to just
2.3:1, the lowest since November 2010. It is far below recent
peaks of 5.6:1 (September 2012), 11.8:1 (February 2012) and
10.6:1 (March 2011) as investors' bullishness about the outlook
for WTI fades (Chart 1).
The liquidation of hedge funds' net length in U.S. oil has
coincided with a significant downturn in WTI prices, confirming
the pronounced link between hedge fund positions and WTI prices
evident since 2009/10 (Chart 2).
Hedge fund bullishness was predicated on upside risks for
the oil market as a whole and the superior relative value of WTI
compared with other international crudes such as Brent. Both
elements have come under pressure in recent weeks.
Prospects for an uncontrolled escalation of tensions in the
Middle East appear to have receded in the short term. With
election day less than 48 hours away in the United States, it no
longer appears likely that Israel will take advantage of the
Obama administration's need to appear tough on defence during
the campaign to strike at Iran.
Once the election is out of the way, a re-elected Obama
administration is likely to take a much harder line with Israel.
If Romney wins, Israel is unlikely to risk souring relations
with the incoming administration by launching strikes during the
transition. So if there was a window of opportunity for Israel
to strike at Iran before the election, it has now closed.
In the meantime, Saudi Arabia and other oil producers have
successfully replaced more than a million barrels a day of
Iranian crude lost from the market as a result of U.S. and EU
An increasing number of prominent analysts are convinced oil
prices have reached a sufficiently high level to ensure adequate
supplies in the years ahead. Current prices of more than $100
per barrel for Brent and $80 for WTI are high enough to make
most new sources of supply profitable, including shale wells and
Canada's tar sands.
In recent weeks, even an improving news flow about the state
of the U.S. economy has failed to rally crude prices.
The relative value case for WTI compared with Brent has also
been reassessed. Hopes that land-locked WTI would close some of
the gap with seaborne Brent following the reversal of the Seaway
pipeline have finally been abandoned.
BP's giant Whiting refinery in Indiana will take offline its
largest crude distillation unit, capable of processing more than
250,000 barrels per day of raw feed, for around nine months and
equip it with a new coking unit as part of an upgrade to enable
it to handle heavier Canadian crude.
The BP distillation unit, 12 Pipestill, accounts for 6
percent of refining capacity in the entire Midwest, according to
Energy Information Administration data.
With so much capacity offline, investors are no longer
confident the crude glut in the heart of the United States will
clear, even with new takeaway capacity provided by pipeline
reversals and the increased movement of oil by rail.
While hedge funds appear to have fallen out of love with
U.S. crude for the time being, it remains unclear whether there
is much potential for shorting the market further.
U.S. crude prices are already towards the bottom of the
trading range that has prevailed since late 2010. The
large build-up of hedge fund short positions suggests the market
may already be oversold and vulnerable to a short-covering
For now, though, most hedge funds seem to have soured on the
U.S. oil market.