Latest exchange data available points to further short positioning in both Brent and WTI. CTAs/ trend following funds have “clean” pivot points and are in control still. As we write, psychological trading damage has been done as price drops hard post strong inventory data across the board.
PRICE ACTION & POSITIONING: The reversal of the extreme negative sentiment was clearly coming, as we mentioned last week. The CFTC, with data included up to Tuesday last week, showed a sizable increase in short positioning in crude, in the order of some 32 mil bbls (Brent -29 mil bbls and WTI -3 mil bbls).
The magnitude of the increase was surprising to us given the rally in oil prices into month end. For perspective, the speculator short base have added 200 million barrels of short positions since the end of May and 377 million barrels since crude prices peaked in the middle of February. This puts speculator pessimism at levels higher than January 2016 when oil prices were in the $30s.
Statistically, oil prices were due for a multi-day reversal. In fact, oil prices were up over $5.00 bbl in eight consecutive trading sessions, until Tuesday, reaching the 50% retracement from recent peak to trough (25th May high down $10.60 bbl to 21st June lows). Brent did not manage to close above its 50% retracement level (In Brent at $49.50 – $49.87 bbl) – SEE CHART 1 –
Once again, this portrays the importance in the current market of pivot points as CTA and momentum type funds continue to drive current market movements (this is backed by analysis, contact us for more on this).
Technical levels continue to prove incredibly reliable. When they cease to have such dominant importance, we will cease to refer to them.
From a portfolio perspective, oil markets were ripe for a sharp speculative repositioning rally into month end, quarter end. In $ notional, assets currently invested in oil and the wider energy complex are just at $12 bil, well below the 5yr average (typically $40 – $50 bil at this time of year). There is obviously a significant amount of dry powder on the sidelines awaiting any confidence in a rebalancing of the oil market in the 2H 2017.
The brief period of optimism, had good legs to stand on: halt in upward pace of US rig additions, slower US monthly oil production gains for April and clearly very bullish DOE data (aligned with Genscape and API).
However, we will not be shy to express the unbiased view here: Price action is terrible, the oil price is under attack and any rebound remains very vulnerable.
Wednesday’s reversal/correction was a stark reminder of the cautious sentiment towards a rebalanced 2H 2017 oil market. The market’s short base received some reprieve from a resurgence in Libya and Nigeria oil production, higher OPEC exports for June, comments from Russia that it will not support deeper production cuts and a stronger US dollar as the Fed policymakers are ready to start the unwinding of quantitative easing within months.
Additionally, Saudi reduced its OSPs to Asia, which could suggest that the market share war within the oil market’s dominant region for demand growth appears to be a long way from settled.
Last, but not least, Total announced a deal to invest $4.8 billion into the South Pars natural gas field in Iran. The amount remains insignificant to the estimated $200 billion of investment required to revive Iran’s antiquated energy sector over the next 5-years.
However, this does mark the first deal since the lifting of sanctions and the market will be taking note to see if the Total deal could pave the way for other international companies such as Shell and Eni, which have already signed provisional agreements to help develop Iran’s oil and gas industry.
The current slide in price means that the street is doing the rounds looking for an explanation other than the CTA pivot points we mentioned above (aka large producer flow).
While there has clearly been a pick-up in producer activity since the return of the US from holidays (especially yesterday via swaps), the market is speculating that large hedging clips by Mexico could be the most recent driver of oil price weakness.
We do not have precise information, we never trust rumours, and we do not know any more than what we can analyse in the market with regards to spreads/diffs. But to us, as the market snapshot is at time of writing, other than being the right time of year for the large sovereign hedge there have been few concrete indications to confirm such hedging activity. Time spreads are not “screaming”, typical of extremely large producer business, and fuel oil spreads and cracks do not imply anything too revealing.
In a way, it does not matter who or what is selling, the fact is that post a palette of improved visible data, oil prices are down hard.
What we do know, are the charts and trigger points, which CTAs use for trend following. It is again a case where the entry/ pivot points for CTAs are very “clean” as it has been a textbook case for weeks now. The failure for the market to close above the 50% retracement line (from recent peak-to-trough), means that CTAs have a green light for a selling entry point. Admittedly, the selloff post-DOEs yesterday is brutal.
Either OPEC/NOPEC need to step in with deeper cuts (and dealing with Libya/Nigeria barrels), taking light sweet grades head on, or some other major catalyst will need to pop up in the short-term. In fact, at the time of writing this report, news articles have suggested that OPEC may consider production caps for Libya and Nigeria.
Otherwise, the answer probably lies in the market needing to see consecutive weekly draws in DOE inventories, similar to this week, for oil to move higher into the year-to-date range.

Chart 1 | ICE Brent Price with key price points | Daily YTD
IMPLIED VOLATILITY: A note on this point as oil volatility is on the expensive side and producers need to adjust their structures to flip this into a monetisation opportunity where possible.
The fact that volatility has remained relatively high on the front maturities is not surprising. The current derivatives market, with an implied volatility at 29% – 30%, prices ~ 90 cents in daily price volatility (options jargon: theta/gamma breakeven). But, the same daily volatility is currently priced throughout Cal 2018 for instance, a daily 90 cents move for 2H 2018 looks to be on the pricey side (at least versus the closer maturities).
The put premium versus equivalent calls (options jargon: put skew) is back to the median average with the mid 2018 level at ~ 5 vol points differential (options jargon: 25 delta calls – 25 delta puts) – SEE CHART 2 – this is an indication of producers back in the market. It provides monetisation opportunities for producers with more flexibility, both on vol and skew differential – contact the desk for more on this.
FUNDAMENTALS: Demand: Consensus demand estimates from the EIA, IEA and OPEC suggest that global thirst for oil could increase by 1.35 mb/d this year. For 2018, available data from the IEA and EIA indicates an acceleration in the rate of the demand increase, to 1.53 mb/d and reach more than 100 mb/d by the 2H 2018.
Supply: Consensus estimates point to non-OPEC supply growth of 800,000 b/d this year, less than global demand (1.35 mb/d) and a key driver towards a rebalancing oil market in the 2H 2017. Investor focus will be on upcoming 2Q earnings reports, primarily from the US shale oil producers. Any signs of higher cost structure or a tempering in capex spending and production growth forecasts should be points of focus.
Consensus estimates for non-OPEC production growth in 2018 has accelerated, driven largely by US shale, albeit Canada and Brazil remain important contributors. In fact, a key driver of capitulation since oil prices peaked in February 2017 has been the pace and magnitude of upward revisions in 2018 non-OPEC supply growth estimates.

Chart 2 | ICE Brent Price, Implied volatility and Skew| Daily Since July 2015
Excluding Russia, non-OPEC supply growth is set to stand at 1.35 mb/d. On average, this is less than demand growth, which should relieve some market share concerns within OPEC, but the speed of upward revisions have been astonishing.
Further, we are having trouble remembering a sustainable period where the IEA has consistently revised its 1-year forward non-OPEC production forecast higher (such as the case is today). The long held pattern from the IEA has been an optimistic forecast of 1-year forward non-OPEC production growth followed by multiple months of downward revisions. The market would welcome such an outcome, but the recent change in the IEA forecasting pattern highlights how disruptive the surge in US shale oil production has been to short-term oil markets.
OPEC exports and production for the month of June have also left the market with little to cheer about. Exempt OPEC members Libya and Nigeria are mostly to blame. We have a hard time extrapolating Libya’s production out further at current levels of almost 1 mb/d as it is not “oil business as usual”, factions are still fighting and volatility is likely to persist. Reports of OPEC enforcing a cap on Libya and Nigeria production highlights that the cartel is looking to address the issue.
Thursday’s DOEs highlight a beat across the board, and an improved picture for visible light sweet crude oil. No doubt, this could raise questions for shorts, particularly if inventory draws continue and especially with so much AUM (i.e. real money long only investors) on the sidelines.
Overall market fundamentals remain favourable with strong refinery margins, elevated refinery throughput (particularly in the US), and the North Sea looking better on seasonal summer maintenance, returning refineries from turnarounds and renewed. Asian buying from S. Korea, Japan and China.
SUMMARY: When bullish news brings lower prices (particularly to this magnitude), it pays to step back and extract information. The fact remains that the current market is engulfed in extreme negative sentiment, where any price rebound provides short with the opportunity to reload. Technicals are proving incredibly reliable and an important catalyst is now required to halt and reverse this momentum.
The derivatives market is pricing Brent for the year-end within the $40 – $56 bbl range and the latest median analyst forecast (recently revised lower) is now below $55 bbl. Average analyst forecasts are currently $8 – $10 bbl higher than the current forward curve. This is unlikely to help present sentiment.
Contact CTC to know more about our risk-management, hedging related services and trading views: contact@comtradingcorp.com.
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