Sentiment in oil markets is extremely bearish. Momentum funds are piling on shorts and have clear targets and pivot points that have worked incredibly well for the past four weeks.
Price acceleration lower appears extended at this point, but there are few signs of trend exhaustion. The $43.50 – $44.00 bbl target we stated for these funds, should provide a bottom. The turnaround in short positioning is extreme, as main chart technicals point to oversold levels. The recent flurry of downward revisions in oil price from sell-side research is probably reaching a peak and could be a good indicator for a price bottom.
PRICE ACTION & POSITIONING: Brent prices are now down 20% from the 25 May OPEC meeting. The market close below the $46.64 bbl support level, where price was “sitting” for three trading sessions, proved to be the key pivot point. This price level was the price low since the OPEC cut announcement, something we highlighted last week.
The break below $46.64, from a chart perspective, means that the only support (and target for shorts) is the $43.50 – $44.00 bbl. This brings us back to a price cluster of intraday lows in November last year. We are practically at that level at time of writing this report.
A note on price pivot levels and triggers: We continue to analyse these technical trading levels, as momentum flows have been the primary market driver. These levels have proved reliable, at least for the time being. When they will cease to have such dominant importance, we will cease to refer to them. They are for us, important for timing and entry points of our clients’ hedges.
From a wider view, speculative positions are a function of our times and the alchemy of recent central bank balance sheet. The open interest for speculative positioning has doubled in past years and the volatility in these flows has increased heavily.
Short positioning is now extreme and the recent turnaround in positioning is record breaking. This is especially true for light sweet Atlantic Basin barrels. Increment supply from Nigeria and Libya, combined with little pull from Chinese teapot refiners has resulted in record short positioning for Brent as the proxy for Dated Brent and seaborne, Atlantic Basin light grades – SEE CHART 1.
We note as well that recent reliable indicators such as RSI on 5, 9 and 14 days are all flashing the current move lower as in oversold territory.
We reiterate from last week: thorough analysis highlights that there are only a few times, historically, where the combination of volume and open interest points to such a dramatic turnaround in positioning – but concentrated within so few dollars/bbl.
The right triggers, such as deeper cuts from Saudi/OPEC, or geopolitical tension could trigger a very violent short covering move to the upside. According to historical data, in a short period (example: 1 day of +10% move), price can move sharply higher and then followed through by higher prices several weeks thereafter.

Chart 1 | BRENT front month & short positioning| Daily since Jan 11 | Source: Bloomberg, ICE & CTC
HEDGING FLOWS: The recent pullback has brought a flip in forecasts lower by the sell-side research. Our read and talk in the market portrays a current sentiment where views are extreme compared to only a few short weeks ago. The landscape currently has two camps, either $30 or $60 bbl with limited views of anywhere in between.
Recent flows are representative of this trend. Analysis of recent option activity points to an increased amount of low delta options traded. Puts with strike prices as low $30 bbl for protection and “lottery” call option tickets with $80 -$100 bbl strikes traded. Certainly, a multitude of geopolitical factors and relatively low options volatility (or overall portfolio, low probability insurance) make these a fair bet.
On the consumer side, it is interesting to note the tendency for this group to become “traders” rather than hedgers as prices move lower. Large consumer hedges have pulled their bids lower, in an attempt to “catch the bottom”.We have done this for too long to know that this strategy does not typically pay off. Often, what ends up happening is that consumer hedging flows end up chasing the market higher on a bounce. In turn, this contributes to exaggerated reverse moves higher.
For completion, we note a recent large trade for Dec17, where 15 mil barrels was traded via a $44/$39 put spread. Observing volatility and skew, it is not a given that the aggressor was a buyer (perhaps a bet that a floor is in, we do not know for sure).
On the producer side, there is very little in producer hedging flows. However, we should put this into context given the massive producer hedging for the first half of 2017, particularly from the US producers. – SEE CHART 2
It is not surprising that the cap in long dated oil prices have been driven by hedging activity of high yield North American producers and Mexico. For perspective, producers hedged approximately 1 billion barrels of oil in the first half of 2017, according to Bank of America Merrill Lynch estimates.
The drivers of 1H 2017 hedging activity were higher oil prices. Producers were opportunistic in locking in higher oil prices secure financing to fund higher capex spending and drilling activity. A kinked futures curve, with much of 2018 in backwardation (yes this was only 1-month ago) reflected this aggressive approach by producers to lock in higher prices.
Even with a brief period of backwardation, producer activity did not slow significantly. In this case, higher prices outweighed the impacts of backwardation as well breakeven economics remained well below the forward curve.

Chart 2 | 2017 Producer Oil Hedging | Source: BofA Merril Lynch (estimate)
As we look ahead, there are a couple of things to keep in mind on producer flow.
The shift to contango on the forward curve. Investor capitulation and the consumer hedging drove the flip from backwardation to contango. Contango has often been an incentive for producer hedging and the key driver of increased producer flows could likely be the trade-off between producers’ cost structures and oil prices.
Approximately, two-thirds of the cost of a shale oil well lies in completion (i.e. pressure pumping). CHART 3 – highlights Goldman Sach’s forecast of pressure pumping demand versus supply in 2H 2017. GS’s current forecasts suggests that costs could increase for this segment of the market, which would ultimately lead to higher
wellhead breakeven levels. The build-up in drilled, uncompleted wells (DUCs) over the last 6-months suggests a growing disconnect between completion costs and oil prices. In any event, a move higher in oil prices could drive increased producer hedging flows as the DUCs serve as a storage mechanism and hedging activity (in a contango market) lock-in favorable economics. One could point to 2H 2015 as a similar environment.
Additionally, North American producers have substantial notes and revolver facilities due in 2019, therefore low prices may not be enough to deter hedging as many producers will have to attract additional equity and high yield financing. Contango and wellhead economics should remain significant drivers.

Chart 3 | Implied Pressure Pumping Demand to Exceed Supply in 2H 2017

Chart 4 | Maturities Schedule for High Yield Notes and Revolver Facilities
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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.
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