LONDON (Reuters) - Even before Iranian general Qassem Soleimani was killed by a U.S. air strike on Jan. 3, ratcheting up tensions across the Middle East, hedge funds had become very bullish about oil prices.
Fund managers amassed an unusually large net long position in petroleum futures and options towards the end of last year in anticipation of the global economy picking up in 2020, but that also leaves prices vulnerable to a correction if the recovery is delayed or fails to materialise.
Hedge funds and other money managers had raised their combined net long position in the six most important petroleum futures and options contracts to 951 million barrels on Dec. 31, the highest for almost 15 months.
Not only was that the largest bullish position of 2019, it was more than double early October’s low of 437 million barrels and triple the low for the year of just 302 million back in January.
Uncertainty and pessimism dominated for the first nine months of the year thanks to the U.S./ China trade war, before giving way to increasing optimism in the final quarter as the belligerents moved towards a truce.
Hedge funds managers ended the year with their highest position in Brent (411 million barrels) and near-highest position in WTI (326 million), according to position data published by regulators and exchanges.
Positions were also very close to their highest in U.S. diesel (21 million barrels) and towards the top of the annual range in U.S. gasoline (106 million) and European gasoil (87 million).
Portfolio managers were net purchasers of petroleum futures and options in 10 of the last 12 weeks of the year, increasing their position by a massive 514 million barrels.
Primarily, the bullishness was driven by an improving outlook for the global economy and oil consumption next year, with oil buying coinciding with the broad rally in global equities and progressive normalisation of the U.S. Treasury yield curve.
Progress on the first phase of a trade deal between the United States and China, as well as three quarter-point interest rate cuts by the Federal Reserve, fuelled hopes for a cyclical acceleration in 2020.
Saudi Arabia’s decision, together with its allies in the OPEC+ group of major oil exporters, to deepen production cuts in the first quarter of this year also helped eased fears about oversupply in 2020.
But production cuts are a second-order effect. The improving consumption outlook was much more important in lifting oil prices. Fund managers were piling into petroleum futures and options long before OPEC+ reached an output agreement in early December.
RETURN TO 1999?
Oil bulls seem to be hoping for a rerun of 1999/2000, when three quarter-point cuts by the Federal Reserve in response to the Asian financial crisis and Russian debt default fuelled a rapid expansion of the U.S. economy in the final frenetic phase of the long boom of the 1990s.
Like in 2019, Saudi Arabia had restrained its oil output through 1999, continuing into early 2000 even as consumption accelerated again.
That lifted prices and sent the futures curve into a big backwardation, something which could happen again in 2020 given a similar backdrop.
Oil prices are not, however, a one-way bet with the main differences this time the unpredictable course of U.S./China relations; a highly uncertain environment for business investment; and the U.S. president’s uncertain tolerance for higher oil prices.
Benchmark Brent prices have also already climbed $14 per barrel (26%) compared with the start of 2019 in anticipation of much of the late-cycle acceleration.
Fund managers now hold a very lopsided position in petroleum, with nearly 7 bullish long positions for every 1 short bearish position.
The long/short ratio has already climbed from less than 3:1 in early October and is heading towards levels that heralded sharp price reversals in April 2018 (14:1), September 2018 (12:1) and April 2019 (9:1).
In early October, the balance of price risks, at least from a positioning perspective, was clearly towards the upside, but that is no longer the case. The balance of risks is now neutral or even tilted slightly to the downside.
If the pace of global economic activity accelerates again, there is potential for prices to rise sharply, unless Saudi Arabia and its allies boost production in a timely manner.
If the global economy disappoints, however, struggling to emerge from its recent slowdown, there are a lot of bullish hedge fund positions to be liquidated, which could drive a sharp price pull back.
John Kemp is a Reuters market analyst. The views expressed are his own.
- “Oil prices rise on optimism about economy in 2020”, Reuters, Dec. 17
- “Hedge funds pile into petroleum on rosier economic outlook”, Reuters, Dec. 3
- “Oil and equities prepare to party like it’s 1999”, Reuters, March 19
Editing by Kirsten Donovan
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