Market sentiment shifts from re-balancing to tightening as a flurry of data, supply concerns and headlines feeds higher momentum.
All stars aligned for OPEC as it “manages” the paper market with leaks of $60/bbl floor for 2018 and full-year extension cuts are fully priced in – Our trader view points to a market now at risk of disappointment coming into Nov 30th meeting.
Oil price strength triggers buying from “passive” index funds and airlines/consumers. Macro funds buying calls for a move to $70/bbl on favourable momentum signals, fundamentals and geopolitics.
SENTIMENT SHIFT FROM RE-BALANCING TO TIGHTENING
Global oil stock draws for October were double the 5yr average, and have set the tone for a shift in market sentiment from re-balancing to tightening. Global oil and refined product inventories (US, ARA, Singapore, Japan) declined by 21mbbls in October, versus the 5yr average draw of 9.5mbbls. Importantly, crude stocks fell counter-seasonally by 4.6 mln bbls, led primarily by stock draws in the US.
Seasonally, crude inventories build in October (10yr average build of 13.7m bbls) due to refinery maintenance. Saudi Arabia’s pledge in early September to reduce October crude exports by 350 kb/d and confirmation of inventory draws throughout October provides all the proof that OPEC is committed to draining inventories to target.
Saudi headlines are in full force, aggressively “managing” the paper market. The upside momentum, pushing Brent to new recent highs, was ignited by “OPEC WANTS TO SEE FLOOR FOR OIL PRICES AT $60 A BARREL NEXT YEAR” hitting the tapes. The source is interesting as well: “FAMILIAR WITH SAUDI OIL THINKING”.
The “sentiment pendulum swing” is now in full force with no sign of trend exhaustion at this point.
CTAs, MACRO, INDEX FUNDS AND CONSUMERS ADD TO BUYING MOMENTUM
Chart signals, trigger points, fundamentals and geopolitical risks have created a cocktail of buying interest from funds ranging from CTAs, macros and passive index money.
Consumers, who missed the past $5 bbl oil move higher, have now entered the mix. We note that, a pattern of panic consumer buying paper flows is typically a late stage cycle of momentum buying.
Investors are buying across the board: Speculative length has reached an all-time high in Brent, WTI, gasoline and distillate.
A positioning-led washout remains a key near term concern, however, a substantial portion of this investor length in Brent was initiated between $55 – 55.85/bbl, providing significant cushion for funds (mainly CTAs) to remain “long and strong”.
Bullish technicals, combined with short-term moving averages crossing long-term moving averages, provides clear signals for CTA and macro fund length to add positions. These are trigger points we monitor for any shake-out in long positioning.
Macro hedge fund interest in oil has seen more 2-way flow (buying and selling). Bullish USD and short commodities (therefore selling oil) remains a key macro theme into 2018 with the view that there will be bumps along the way as Central Banks withdrawal liquidity from the market.
On the other side, macro buying has been driven by a pickup in economic growth and the tightening of supply due to under-investment and OPEC’s success in reigning in production. Geopolitical risks (Venezuela, Iraq/KRG and US/Iran) are icing on the cake and hence the interest in owning $75 calls.

US consensus oil production | BBG, MS & CTC
PRODUCER HEDGING ACTIVITY
Our analysis of producer hedging activity points to a surge of volume on two days last week but otherwise volumes are well below the activity reached in September.
There is a notable pattern with relatively low hedging on WTI versus seaborne crude. Brent-linked hedging has increased with European hedging driven by deal closures from recent M&A activity.
Lower US activity is driven by larger E&P companies (3-ways and fences). The majority of smaller producers, hedged using swaps, have positions underwater (or near) which is limiting credit availability for new hedges.
There are now important, price impacting dislocations in the options market between hedging structures – CONTACT THE DESK FOR MORE ON THIS –
US SHALE OUTLOOK MIXED BUT EXPECTATIONS REMAIN OPTIMISTIC
Near-term production guidance was revised lower, however, the verdict is still out whether returns win out over growth. The interesting takeaway is that Q4 2017 consensus production estimates have been revised lower – SEE CHART – Though, 2018 production forecasts remain relatively stable. In other words, implied growth rates are higher than June forecasts, despite rig activity falling over that period.
We see downside risks to these forecasts unless oil prices continue to move to higher levels, which incentivize adding more rigs.
The verdict is still out on US shale production growth but its role as a swing producer doesn’t seem to be hold water as recent increase in oil prices bring little in terms of supply response. The stars are all aligned for Saudi !
OUR CONCERNS ON DOWNSIDE RISKS AS WE APPROACH 2018
Over the past 3-months, CTC has laid out a bullish outlook for oil prices on the basis of improving fundamentals, rising geopolitical risks and constructive trading/trigger points.
However, there are a number of factors that keep us awake at night and we remain wary given the size of the speculative length:
OPEC meeting: The market has moved beyond OPEC’s decision to extend production cuts throughout 2018. This is now fully discounted into the market. As oil prices move higher, our concern is that OPEC misreads investor sentiment and sends an unclear message on OPEC.
Oil demand growth for 2018: Consensus (IEA, OPEC, EIA) oil demand growth is 1.6mb/d in 2018. This is above trend growth of 1.5mb/d over the past 5-years. Low oil prices drove average demand growth of 1.7m/d between 2015-2017. Will oil demand growth be as robust if oil prices are in the $65-70/bbl region?
US shale: Capital discipline and returns over growth is up for debate for US shale and Q3 results seemed to shed less light on a clear-cut direction. The implications will have a significant impact on oil prices.
Fed policy and changing of the guard: Change is not always easy and the appointment of Jerome Powell as the next Fed Chairman suggests the status quo. While that may be the case, central banks globally are transitioning to a period towards unwinding monetary liquidity.
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Commodities Trading Corporation is a London-based private advisory company specialized in commodity risk-management and hedging. We service a growing need in the natural resources sector for unbiased and strong expertise and provide our services to an array of corporate clients and financial institutions. We are experts in derivatives and monetizing volatility and develop corporate strategies for hedging energy portfolios, using bespoke derivatives solutions for price risk mitigation.
For more information about what we do, how we can optimize your hedges and directly improve your bottom line, contact us at contact@comtradingcorp.com.
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