July 12, 2018 / 2:40 PM / 6 days ago

COLUMN-Brent stumbles as market resets after year-long rally: Kemp

(John Kemp is a Reuters market analyst. The views expressed are his own)

* Chartbook: tmsnrt.rs/2LbhIwR

By John Kemp

LONDON, July 12 (Reuters) - Brent crude prices registered their largest one-day fall in more than two years on Wednesday, in what was probably an indication hedge fund managers and other traders are realising profits after a year-long rally.

Front-month futures slumped by $5.46 per barrel, or just under 7 percent, a daily price move more than three standard deviations away from the mean, and the largest one-day decline since February 2016.

The market has suffered a larger percentage decline on only 44 days since the start of 1990, and it comes after a long period in which price volatility has been very low by historical standards.

Traders and analysts have blamed the sudden drop on a cocktail of factors, including the reopening of oil export terminals in Libya and the worsening trade dispute between the United States and China.

There have also been hints the United States will grant at least some waivers for countries to continue importing Iranian crude, easing fears of an extreme supply crunch after sanctions are reimposed in November.

Saudi Arabia also sharply increased exports in June and is expected to raise them further in July, helping relieve fears about future shortages.

The most likely explanation is a combination of all these factors, coupled with stretched market positioning and a lack of liquidity.

Brent has shown signs of topping out for some time, even as prices remain close to their highest since 2014 (tmsnrt.rs/2LbhIwR).

Buoyant flat prices have concealed signs of weakness elsewhere in the calendar spreads as well as hedge fund positioning.

Brent spreads, which cycle between contango and backwardation as the oil market alternates between over- and under-supply, have been softening for more than a month.

The six-month futures spread peaked in a backwardation of $3.50 per barrel in late April, and had slipped to just $1.76 on Tuesday, before plunging to 63 cents on Wednesday.

Hedge funds and other money managers have cut their bullish position in Brent futures and options from 632 million barrels in early April to just 457 million barrels by July 3.

Portfolio managers hold just over eight bullish long positions in Brent for every bearish short position, but the ratio has come down from 20:1 in April.

At the same time, fund managers have been gradually working down their bullish positions in refined fuels such as gasoline, heating oil and gasoil, contributing to downward pressure on crude.

Overall, the fund community remains bullish on oil, anticipating that strong consumption growth and further disruptions in production will tighten the market even further in 2018 and 2019.

But they are less bullish following the 75 percent run-up in Brent prices over the last 12 months and the market’s failure to break through the previous highs set in May.

Fears about future supply disruptions have failed to push prices higher and cast doubt on the potential for further short-term gains.

The resulting profit-taking has gradually sapped the momentum from the rally and probably contributed to the lack of liquidity behind Wednesday’s price move.

The sharpest price drops were concentrated in near-dated futures contracts, which are where many hedge fund positions are held.

Even after profit-taking in recent weeks, fund managers still held a historically high and lopsided bullish position in Brent futures, leaving them vulnerable to another bout of profit-taking.

U.S. crude futures prices have remained supported by the interruption of pipeline deliveries into the U.S. Midwest as a result of the shutdown at Canada’s Syncrude plant.

Hedge funds have actually been buying U.S. crude futures, adding 116 million barrels of net bullish positions in the last two weeks, even as they left Brent positions unchanged.

But Brent has had no such local factors to support the market and on Wednesday it finally seemed to succumb to a profit-taking plunge.

Markets exhibit strong cyclical behaviour. Once prices stop rising, they tend to fall, rather than hold at the peak.

And the sharpest price falls in a market come not straight after the peak, but normally when prices have been under gentle pressure for some time, and the initial trickle of selling finally turns into a torrent.

That is likely what happened on Wednesday.

Related columns:

- Hedge funds target WTI, leaving other oil contracts becalmed (Reuters, July 10)

- Hedge funds continue selling oil, especially fuels (Reuters, July 2)

- Hedge funds continue gently selling oil while waiting for OPEC and tariffs (Reuters, June 18)

- Oil prices stall as hedge funds take profits (Reuters, June 12) (Editing by Dale Hudson)

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