(John Kemp is a Reuters market analyst. The views expressed are
* Chartbook: tmsnrt.rs/1SIArx4
By John Kemp
LONDON, Dec 7 Successful trading rule No.1: do
not enter any significant position until you have worked out an
eventual exit strategy.
Rule No.1 is especially important if the position is large
relative to the overall market or a large number of traders are
all trying to put on the same position at the same time because
the position could strain available liquidity.
The question of an exit strategy has become pressing in the
oil market because of the enormous short positions accumulated
by investors in the expectation oil prices are about to fall
Hedge funds and other money managers had amassed short
positions amounting to 172 million barrels of crude oil in the
main futures and options contract on the New York Mercantile
Exchange (NYMEX) by Dec. 1.
It was the third-largest short position ever recorded, after
the 178 million barrel short positions reported earlier this
year on March 24 and 31 (tmsnrt.rs/1SIArx4).
Short positions on NYMEX have almost doubled over the last
seven weeks from a recent low of just 90 million barrels on Oct.
If short positions in Brent are included, hedge funds have a
combined short position of around 300 million barrels.
CARRY ON PUMPING
Oil ministers from the Organisation of the Petroleum
Exporting Countries (OPEC) ended their meeting on Friday without
any agreement on production.
The meeting had not been expected to agree on output cuts
but failure to agree on any production target at all, even a
fictional one, took the cartel to new levels of disarray.
Saudi Arabia, Iran and Iraq are all now set to produce as
much as they can in a bid to defend their market share and
Russia has already increased its output to a record level
and is expected to continue pumping as much as it can during
U.S. shale producers have seen output decline, but only
modestly, while production from the Gulf of Mexico is actually
OPEC is relying on strong consumption growth in 2016 to
absorb the resumption of Iran's oil exports and all the other
sources of extra supply.
OPEC's economic projections show global economic growth
accelerating from 3.1 percent in 2015 to 3.4 percent in 2016.
In the meantime, however, the market remains oversupplied,
with rising stockpiles of both crude oil and refined products.
Most market analysts believe oil prices will now head even
lower until U.S. oil producers stop drilling, stripper wells are
shut in, or there is a change of heart in Riyadh, Teheran and
WHAT NOW FOR PRICES?
The critical question is how that bearish outlook interacts
with the enormous short position amassed by the hedge funds.
The simple answer is oil prices will fall and the hedge
funds will gradually be able to close out their positions in a
Prices have already slipped modestly by 50 cents on both WTI
and Brent since the OPEC meeting ended without agreement.
But the large number of short positions to be bought back
and closed out could provide some support for prices in the near
If prices do not fall as the hedge funds expect, at least
some of them will probably try to trim their positions and book
In both March and August this year the establishment of
large short positions preceded sharp short-covering rallies.
In both cases, the initial short covering was relatively
small scale and had little impact on prices; the main short
covering rally arrived two to three weeks later, and saw prices
leap by more than $10 per barrel.
Uncertainty about what happens next explains why implied
volatility in oil options has soared: fundamentals point to a
further drop in oil prices while market positioning points to a
(Editing by Susan Thomas)