By John Kemp
LONDON May 14 Bullish investors finally
abandoned hope for a recovery in oil prices, at least in the
short term, in the week ending May 8, slashing their long
positions in WTI-linked futures and options by the largest
amount in more than five years.
Hedge funds and other money managers reduced their long
position in U.S. crude by the equivalent of nearly 54 million
barrels of oil, the largest one-week decline since at least June
2006, according to data released by the U.S. Commodity Futures
Trading Commission (CFTC) on Friday (Chart 1).
The long liquidation was three times greater than in the
"flash crash", almost exactly a year ago on May 5, 2011, when
speculative longs were cut by a little under 19 million barrels.
Tumbling prices drew some fresh interest from speculators on
the short side. Money managers boosted their short positions in
WTI-linked contracts from 48 million barrels to 75 million, the
highest level recorded for seven months.
The ratio of hedge fund long to short positions halved from
6.2:1 to just 3.2:1, the lowest since October 2011, and far
below the recent peak of 11.8, back at the height of the oil
price spike in February (Chart 2).
Net long positions held by hedge funds and other money
managers have fallen from 304 million barrels on February 28 to
just 169 million barrels on May 8 (Chart 3).
The net long position has fallen to seven-month lows,
reversing all the build up in speculative length since October
CURIOUSER AND CURIOUSER
Long liquidation by the hedge funds and commodity trading
advisers (CTAs) will grab the limelight, but the other side of
those position changes is just as interesting.
Part of the adjustment came about from a fall in the massive
net short position run by banks and other swap dealers, which
was down by 27 million barrels. Another chunk came from a drop
in reported producer/processor/merchant/user net short
positions, down 15 million barrels.
But a big and unexplained chunk was simply transferred to
the mysterious "other reportables" category. Net long positions
held by other reportables rose just over 27 million barrels to a
record 171 million barrels.
Other reportables boosted their long positions by 11 million
barrels and cut shorts by 16 million barrels. Other reportables
now have larger gross long and short positions, and a larger net
position, in the market than hedge funds, CTAs and other
classified as money managers.
The overwhelming bulk of other reportables' positions are
held in the main NYMEX light sweet crude oil futures and options
contracts, or in NYMEX calendar swaps, with a few more in
average pricing options, with minimal holdings in European-style
options and financial settled contracts.
The category is the fastest-growing participant in the WTI
futures and options market, according to CFTC data, but almost
nothing is known about the traders in this segment.
The CFTC defines them simply as "every other reportable
trader that is not placed into one of the other three categories
is placed into the other reportables category," which is not
Repeated requests to the Commission's staff to explain what
sort of firms are classified under this heading, whether the
classification has changed, or if the rise in other reportables'
position is due to organic growth, have failed to elicit any
What is clear is that other reportables have become crucial
liquidity providers. Their willingness to take the other side of
hedge fund/CTA positions helps explain why prices have moved so
smoothly in recent months, despite the hefty accumulation and
then liquidation of hedge fund holdings.
It goes some way towards explaining why the much larger long
liquidation seen in the past fortnight has not generated the
same flash crash as the much smaller liquidation in May 2011.
Market participants should press the CFTC for a more
satisfactory explanation of the sort of firms being classified
under this heading, which has become an expanding "black hole"
in the commitments of traders report.
BEHAVOURIAL TRADING RISES
The cyclical accumulation and then liquidation of hedge fund
long positions over the last seven months shows the increasing
role of behavioural trading in the oil market.
While fundamental traders take a position based on their own
evaluation of supply, demand, inventories and spare capacity,
behavioural traders are more interested in the views of other
market participants. Behavioural traders are anxious to spot and
join the big waves of enthusiasm and repudiation that sweep
Most behavioural trade is grounded in fundamentals, at least
at first, but the accumulation and liquidation of positions then
takes on a life of its own as the market constructs its own
Something similar appears to have happened with crude oil
over the past six months.
The threat of sanctions on Iranian oil exports, rising
tensions between the western powers and Tehran, coupled with a
string of supply outages from South Sudan and Yemen to the North
Sea, was enough to prompt hedge funds to assemble a near-record
Initial positions may have been established by fundamentals
and the smart inside money, but once the trend was underway, the
rally seems to have drawn in large amounts of behavioural
Once the market had peaked, however, it is this behavioural
money that has headed for the exits, slowly at first, but
This sort of liquidation (where slow selling at first
triggers an avalanche of later sales) is characteristic of asset
markets with strong behavioural or bubble characteristics.
Liquidation during the last fortnight is hard to square with
any other explanation. Most of the bearish factors weighing on
oil prices (rising Saudi output, swelling crude inventories,
de-escalating tensions with Iran, signs of slowing growth in
China and the eurozone, and a stalling labour market recovery in
the United States) have actually been evident for some weeks, if
not a month or more.
Nothing changed in the fundamentals in the week ending May 8
that could explain the huge liquidation of hedge fund long
positions. Instead it appears to have been driven by the
accumulation of selling itself, and the steady retreat in
prices, that eventually convinced many fund managers that this
time there would be no bounce back, and the uptrend was well and
truly broken for now.