January 30, 2018 / 1:02 AM / a month ago

RPT-COLUMN-Hedge funds pile into oil despite rising risk of a correction: Kemp

(Repeats with no changes. John Kemp is a Reuters market analyst. The views expressed are his own)

* Chartbook: tmsnrt.rs/2EifLfr

* Chart 1: tmsnrt.rs/2DIoGG6

* Chart 2: tmsnrt.rs/2EkJBQA

By John Kemp

LONDON, Jan 29 (Reuters) - Hedge funds continue to increase their bullish positions in oil, even as prices hit the highest level since the slump began in 2014, brushing aside concerns about overheated markets and the risk of a correction.

Hedge funds and other money managers raised their net long position in the six most important futures and options contracts linked to oil by 44 million barrels to a record of 1,484 million in the week to Jan. 23.

Portfolio managers have raised their net long position in Brent, NYMEX and ICE WTI, U.S. gasoline, U.S. heating oil and European gasoil by the equivalent of 1,174 million barrels since the end of June.

Hedge funds are more bullish on the outlook for petroleum than at any time on record, even though benchmark Brent prices have already nearly tripled over the last two years (tmsnrt.rs/2EifLfr).

The ratio of hedge fund long positions to short positions has climbed to a record 11.51:1, up from a low of just 1.55 at the end of June.

Since the start of 2015, such lopsided hedge fund positioning has usually preceded a sharp reversal in the recent price trend.

But most fund managers seem unconcerned about the threat of a short-term reversal because the medium-term fundamentals appear solid.

Oil consumption is growing rapidly as a result of synchronised growth in the major economies. OPEC and its allies have reiterated their commitment to output restraint. And global inventories are falling.

Portfolio managers increased their bullish positions in every element of the petroleum complex in the week to Jan. 23.

Net long positions rose in Brent (+14 million barrels), WTI (+8 million barrels), U.S. gasoline (+12 million), U.S. heating oil (+4 million) and European gasoil (+6 million).

Net long positions are at record levels in every contract and in most contracts the ratio of long to short positions is at a multi-year highs.

Brent prices are close to their 10-year average ($82 per barrel) and already above their average over the last complete cycle from 1998 to 2016 ($64).

The implication is that petroleum prices are no longer cheap but still have room to rise further as the price cycle matures in 2018 and 2019 (tmsnrt.rs/2DIoGG6 and tmsnrt.rs/2EkJBQA).

Oil consumption is expected to continue rising strongly thanks to fast growth in the global economy and world trade.

The principal risks come from an acceleration in U.S. shale drilling, declining compliance in OPEC and its allies, increased production from non-OPEC non-shale sources, or a deceleration in demand owing to rising prices.

None of these risks appears likely to materialise imminently but they will all increase the higher that oil prices rise.

As with almost all relationships in the oil market, the relationship between these risks and oil prices is highly non-linear.

Risks will increase even faster than prices. The higher prices rise, the greater the risk from increased shale and non-shale drilling, the greater the chance of non-compliance and the more likely demand will slow.

The other source of risk comes from within the market itself. The higher prices rise the greater the temptation for hedge fund managers to try to realise some profits by selling a proportion of their long positions.

The extremely lopsided positioning of the hedge funds and other money managers in the oil market has created a significant source of fragility.

Fragility does not mean a correction will happen soon, but it does increase the probability even a small increase in production or slowdown in consumption could trigger a relative large downward movement in prices.

Related columns:

“Hedge fund trade in oil becomes very crowded”, Reuters, Jan. 22

“OPEC’s focus on stocks risks prices overshooting”, Reuters, Jan. 3

“Hedge funds gamble OPEC will tighten oil market too much”, Reuters, Jan. 2

Editing by David Evans

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