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Oil Producer Report

Oil Trading Report: OPEC price gains wiped out – Momentum funds selling hard – Paper market anxious for Saudi guidance – Opportunity for producers to restructure

Oil is down $10 bbl since recent highs, erasing all post OPEC/NOPEC price gains. Market struggles to explain the selling, as not driven by fundamentals.

Momentum funds are in position of strength with clear targets ahead.  The market, especially participants with positions caught offside, is eyeing any signal from Saudi Arabia for price direction.  Any price recovery could be explosive as the short strike above could amplify buying as witnessed on the move down.

Chart technicals still point to further selling ahead: however, risk/reward suggests a good buying entry point. For commercial producers, current market conditions provide an opportunity to restructure and optimise hedges.

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PRICE ACTION:  Prompt Brent crude oil is trading ~$48 bbl, down $10 bbl since the April 12th high and down over 10% this week alone.  The last $2.5 bbl down has felt particularly painful as it completely breaks the $50 bbl “line-in-the-sand” we/the market was using as a floor.

The break of the 200 DMA (200 day-moving-average) proved critical with RBOB, the bad omen, leading crude oil flat price direction again.  The break of the $50 bbl level, triggered immediate volume selling.  Preliminary open interest data from the CME and ICE, show 84,000 new shorts in oil on Thursday.

Additionally, volume sweeps through lower bids contributed to the downward price momentum. This trading pattern suggests that CTAs were aggressive sellers and key contributors to the increase in new short positions. It also points towards amplified volatility and selling as oil prices fall below key put strikes where dealers are short through previous producer hedging.  Indeed, short gamma means more flat price selling as price heads lower.

The next important chart levels are at $45.75 – $45.92 area (cluster levels going back to Nov).  A close below these levels opens the path towards the Nov lows of $43.50 bbl.

For now, from a chart technical point, the trend remains negative and the path clear for CTAs to continue selling.

To the upside, the first most important level, in our opinion, is yesterday’s VWAP level ($49.39 bbl in Brent and $46.37 bbl for WTI).  A price move above would catch recent shorts offside and likely trigger a short covering rally. The only clear buy signal is a market settle above $50 bbl for Brent.

The only solace is that the amount of selling, combined with the explosion in increase open interest and oil trading through short put strikes levels, means that the intensity of the selling should diminish and that could mark a firm bottom in the market.

Chart 1 – Brent– 6 month –Source: Bloomberg & CTC

Chart 1 – Brent– 6 month –Source: Bloomberg & CTC

HEDGING FLOW & POSITIONING:  As market participants are scratching their heads to explain the violence of this selloff, there is a tendency to “hindsight trade” and cherry pick news stories with aim to justify it.

However, the key answer to the sell-off points towards a combination of long positioning, and significant volumes of CTA/trend following fund flows aggressively selling.  The move down was exacerbated by the short gamma positions (from producer strikes and recent short dated option flows), now above. Option flows, counterintuitively perhaps, point to clear buying flowsConsumers are buying across the barrel (from fuel, to diesel, to jet).

Hedge funds have been buyers of calls and call spreads in size.  Note that there are reports of commodity specialised funds (Andurand) may have liquidated.  F|or sure he is not alone and like us caught by the acceleration down. Though we note there was buying activity from macro/generalist funds. Last night the breach below $45 bbl in WTI triggered 16k lots of front month selling, only to be bought back on the London open by hedge funds, consistent with option flows.

From the (commercial) producer side, non-existent selling, only restructuring activity seems to have gone through and pointing towards buying back of hedges (converting swaps to collars mostly) –  SEE CHART 2 – So the flows are clear, hedge funds/ managed money liquidation being bought by consumers and producer buybacks.

There is indeed, some whisper of PEMEX back hedging.  It is not possible for us to confirm or negate, only to say that the options market, amongst the recent noise, does not appear to reflect these hedges. Could it be the trigger that lead to the selloff? We think not, perhaps more an attempt to explain, the often little grasped, short gamma option positions.

FUNDAMENTALS:  The price gains since the OPEC/NOPEC deal have been completely wiped outCompliance on the cuts has been exceptionally high, above 90% but the US have increased production by 400k – 500k bpd since December 2016.  For OPEC, the culprit is contango, which despite the impressive cuts; permits US producers to hedge out on the curve. The market is also eyeing the possible return of Libyan and Nigerian barrels.

Since the OPEC deal announcement, light sweet grades from the US and NWE have found a home in Asian refineries, mostly to the detriment of Saudi market share. These are some of the psychological “dents” affecting the bullish case.

Assuming, an extension of the deal and a rollover of the same terms, we see oil prices trading higher. Global oil stocks should draw (first time since 2013). The second half of the year is also historically the tightest.

Chart 2 – Brent curve – last VS 28 Apr –Source: Bloomberg & CTC

Chart 2 – Brent curve – last VS 28 Apr –Source: Bloomberg & CTC

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