Fundamentals, macro drivers and explosive geopolitical risks underpin a healthy backdrop to the crude oil market into the OPEC meeting on 30 November.
Sentiment is upbeat, while record net length in Brent poses the greatest risk for a pullback. Higher prices brought responsive selling from producers over the past week.
We target $52.50/bbl as a floor and recommend producers capitalize on technical positioning and temporary “washouts” to restructure and optimize hedging portfolios and strikes.
Overall, we view a backwardated Brent curve, in the context of a weaker USD, as a powerful bullish driver for oil prices to trade in the upper end of the $50-60/bbl trading band into year-end, particularly given the breadth and rate of increase in global oil demand year-to-date.
KEY RISKS REMAIN ON POSITIONING, FUNDAMENTALS ARE SUPPORTIVE: Positioning across the oil complex (Brent, WTI, gasoil, heating oil and RBOB) is near the record highs set in late Feb17. WTI positioning looks benign relative to the record levels in Brent and refined products. Backwardation (positive roll-yield) in Brent, structural view for a weaker USD in combination with growing geopolitical risk and a hurricane disrupted distillate market has attracted index investor and CTA flows across the oil complex.
PORTFOLIO FLOWS ROTATE TO COMMODITIES: We highlighted in early September the possibility of $30-50 bln of capital on the side-lines that could re-enter the oil complex in short order.
Our calculations point to a significant portion of capital has now been deployed (over the past 6-weeks). Investor positioning has increased to $45-50 bln from less than $20 bln in mid-to-late summer. This brings us into the upper band of historical ranges with approximately 60-65% of the new capital deployed in Brent alone.
The influx of investor flows has led to Brent’s best Q3 return (+20%) since 2004. However, signs of investor nervousness are palpable with Brent down ~6% from the recent highs.

CHART 1 | OIL COMPLEX POSITIONING | SOURCE: NYMEX, ICE, CTC
Price weakness comes despite clearly bullish headlines:
1) growing tensions between Turkey/Iraq in Kurdish region with reports that Iran deployed tanks and artillery to the border.
2) reports of supply disruptions in Libya with Sharara field down (230k bpd) and Nigeria exports for November to be down 190 kb/d
Yet nothing was enough to support prices short-term. Price weakness combined with a cocktail of bullish news is a clear signal that positioning is maxed out. After absorbing the record flows of producer hedging over the past month, there are few buyers remaining to take prices higher.
WATCH OUT FOR THE “PIVOT POINT”:
It is important to note that a substantial portion of this additional investor length was initiated in the $55-55.85/bbl. This is a key “pivot point” to monitor in the near-term. Moreover, our proprietary model points to ~$1.5 bln of long positioning in Brent, initiated early last week, has been “caught offsides”. This is the source of the investor selling flows which led to the recent ~6% pullback and could be a cap to near term prices.
To be clear: the speculators long who were deep in the money and able to “take pain” on their trades just a week ago, are now caught barely breaking even and in a much weaker position.
Any further pullback will inevitably feed on itself as the weaker longs have to sell in front of the others, risking to trigger a “first to blink” price retracement. As the simplistic yet succinct floor broker quote goes “escalator up but elevator down”.
OPTIONS VOLATILITY:
Over the past week there have also been some notable moves in the differentials of calls versus put volatilities. This will have a large impact on producer hedging costs and will vary significantly from cost-effective to pricey structures. For example, in Brent put volatility has widened by over 2% versus calls and is at a 6-month high driven by curtailed spec buying and healthy profit taking from call-owners (take-profit from consumers).
A backdrop of strong fundamentals, led by refined product demand, growing geopolitical risks (Kurdistan, Iran and Venezuela) and a weak USD sets the stage for shallower pullbacks than what we have seen year-to-date.
We are targeting $52.50 bbl for the lows (ICE Brent). We advise producers to capitalize on a positioning/technical pullback to restructure and optimize hedging portfolios and option strikes – CONTACT US FOR MORE ON THIS –

CHART 2 | PRODUCER HEDGING FLOWS | SOURCE: MORGAN STANLEY, DTCC
MACRO & GEOPOLITICAL FACTORS SUPPORTIVE:
Oil price performance has historically had a long-term correlation to macro and geopolitical factors. The magnitude changes over short time periods but we look to be entering a point where both macro (a structurally weak USD) and geopolitical factors combined with strong fundamentals underpin Brent prices into year-end.
The US Trade Weighted Broad Dollar is down ~3% on a 12-month basis and if it doesn’t recover, 2017 could be one of the worst years since 1973. It is down over 12% versus the EURO (even after Catalan tension) and even against GBP (given the Brexit headlines) it is down over 7%. The key takeaway here is that a structurally weak USD is (very) supportive to Brent, certainly for the upper end of the $50-60/bbl trading range coming into year-end.
Geopolitical risks have also moved to the forefront and with S/D tightening a risk premium is likely to be embedded in oil prices. The issues are not new, Kurdish independence, Venezuela uncertainty and the 15 October deadline for the US to roll-over sanction waivers on Iran. All pose potential risks for temporary supply disruptions. We tend to forget how oil used to trade not so long ago – A geopolitical risk premium has been baked into Brent as reflected in the widening WTI-Brent spread and the record net length in Brent versus WTI. Our analysis puts the current “geopolitical risk premium” at $2 – 3 bbl currently. A tighter S/D market going forward would increase that obviously.
US equities hitting new highs on a weekly basis. The S&P500 up 13% year-to-date contributing to “risk-on” macro support from earnings growth and general positive sentiment towards overall macroeconomic activity. Additionally, the outperformance of equities versus other asset classes year-to-date has encouraged flows into alternative investments such as Brent, which is down roughly 1% YTD.
PRODUCER HEDGING:
Producer hedging activity hit near record highs over the past month. The average daily hedging volumes hit >20 mbbls for this category and clearly was the dominant flow. There has been a clear distinction now between small hedgers, hedging via swaps to lock-in levels (like gasping for oxygen) and on the other, producers with more flexibility (higher quality assets) selecting zero-cost 3-way structures to hedge. The result of this flow, net selling volatility, has impacted option volatility greatly. Producers on the other hand, have not been chasing price lower in past days and analysing OTC volumes shows that since this Monday hedging practically halted (like an “off button was pressed”).
The surge in hedging since 1st week of Sept, has now brought the hedge ratio for the sector in-line with averages in past years. This is important as there is less back end selling pressure into year-end at current prices.
For oil producers in the EMEA region (Brent related crudes), the story could be just the opposite. Hedging activity may be set to increase into year-end as a number of M&A deals (mostly in the North Sea) are set to close in 4Q17 and 1Q18. Cumulative production from these announced deals is roughly 475 kboe/d and we expect to see hedging flows pick up once these announced acquisitions close.
While we remain constructive on oil prices into year end, the current backdrop appears insufficient to sustain oil prices above $60 for an extended period as compliance on the NOPEC/OPEC production-cut would diminish, and $60/bbl would provide plenty of incentive for producers to ramp up hedges.
Contact CTC to know about more about how we help with risk-management, hedging related and trading views: contact@comtradingcorp.com.
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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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