By John Kemp
LONDON Oct 28 For all the bullish talk about
tight supplies next year if the global economy skirts renewed
recession, and occasional sharp short-covering rallies,
benchmark oil prices are softening.
In the past six months, each of a series of sharp
short-covering rallies has pushed the front-month Brent futures
contract to peak at a lower level than the previous one:
$127 on April 11, $126 on April 28, $121 on June 15, $120 on
Aug. 1, $116 on Sept. 8, $114 on Oct. 14 and now $112 on Oct.
Gradual subsidence in prices is not confined to nearby
futures contracts. The same pattern of successively falling
peaks is evident in the price of contracts for deferred delivery
in Dec 2012 and Dec 2013 .
It stands in marked contrast to the continuous uptrend in
prices through 2009 and 2010, which culminated in April 2011, in
which each temporary peak was higher than the last (with one
limited exception in the late spring of 2010).
Sustained downtrends have been rare since the great upsurge
in oil prices started in 2003 ().
Prices have eased despite several potentially bullish
factors: (1) reported tightness in the cash market evidenced by
premiums for quality crude and steep backwardation in the Brent
forward curve; (2) the Fed's commitment to keep interest rates
lower for longer and attempt to pull down long-term rates; (3)
rallying equities; (4) continued demand growth in Asia; and (5)
warnings from prominent forecasters at major commodity banks
about continued upside price risks from a tightening
supply-demand balance in 2012.
Hedge funds and other money managers remain convinced oil
prices will rise. The ratio of money managers with long
positions in WTI-linked futures and options to those running
short positions remains at three to one, according to data
released by the U.S. Commodity Futures Trading Commission (CFTC)
For Brent futures and options, the long/short ratio is
1.77:1, according to Intercontinental Exchange (ICE), lower than
earlier in the year but still bullish.
Physical traders are also bullish. "Bullish physical oil
traders, who have been warning for months of a tightening
market, have so far won the game against bearish macroeconomic
hedge funds," as my colleague Javier Blas wrote in the Financial
Times on Tuesday ("Swing in WTI price curve leaves oil traders
reeling", Oct 25).
U.S. equity markets have also been doing well recently
. But benchmark seaborne crude prices have been largely
left on the sidelines during the relief rally.
DOWNTREND FOR NOW
It is not necessary to believe in either strong versions of
the efficient markets hypothesis (EMH) or the forecasting power
of technical analysis to perceive something structural has
changed in current fundamentals or expectations about the
The downtrend started back in the late spring, long before
there was an end in sight to the disruption of Libyan oil
supplies and also before the markets began to fully appreciate
the risks of a synchronised global slowdown.
The downtrend is probably due to a combination of factors:
(a) expected resumption of Libyan oil exports; (b) cuts to
projected global growth; (c) downward adjustments in forecast
oil consumption; (d) liquidation of the record long positions in
oil derivatives taken by money managers in late 2010 and early
2011; and (e) improved confidence in medium-term oil supplies as
a result of tight oil and other technologies.
Market perceptions of ever-increasing supply shortages and
escalating prices appear to have given way to greater confidence
(complacency?) about the supply-demand outlook.
It is also possible market participants now perceive oil
prices have reached a threshold or ceiling where further
increases generate slower global growth and are therefore not
sustainable except in the very short term, capping gains.
Nothing guarantees the market is right and that prices will
not resume a sharp upward trajectory. Like other financial
markets, commodity markets are notoriously fickle and
inefficient at processing information. As one senior energy
trader remarked: "The forward curve is not a forecast; it's what
we bet against".
There have been plenty of times when the market has been
wrong or over-reacted. Oil analysts may be proved right in
warning that the market is far too complacent about the
supply-demand situation next year and is under-pricing upside
risk (for example in the options market).
But the price on the screen represents the balance of views
among those willing to risk their money. For all the reported
bullish comments around the market, talk of looming shortages,
and fierce rallies, prices have been ebbing for six months.
If the market is even loosely efficient in processing
information about current and expected supply, demand,
inventories and spare capacity, the sustained downtrend
indicates a significant change in the outlook that needs to be