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Is The Oil Price Slump About To End?

Derek Wolfe

Updated: August 2, 2022

oil price slump
Editor’s Note:

EDITOR'S NOTE: What many investors don’t understand about the futures market is that there can be more of a commodity in “paper” than there may be in the real market. This is how commodity prices, like the one we’ve been seeing in gold, can easily be obfuscated. If price is a signaling device for real supply and demand, then having an excess of paper equivalents can cause prices to disassociate with economic reality. It’s not unlike fractional reserve banking, where a bank can lend out multiple times the amount of money it has in deposit (which is also why bank runs can be devastating for any single bank). This also describes the current oil price slump, as many hedge funds went short the commodity via futures. But this decline doesn’t give us a clear picture of supply and demand. If anything, it was a mirage of paper manipulation. And that price trend may now be subject to a reversal, according to the article below. How might that impact us? Perhaps we’ll find that answer at the gas pump, or the price of food, or pretty much everything else that’s energy-reliant. More importantly, are you hedged adequately to mitigate the potential impact of this next wave of skyrocketing costs?

  • Money managers have started to close out short positions on oil.
  • The oil price slump that started mid-June could be about to reverse.
  • The disconnect between the physical crude market and paper crude market remains large.

Short sellers are closing out short positions against oil-focused exchange traded funds, while money managers have modestly increased their holdings of crude oil futures over the latest reporting week. These trades suggest that speculators, traders, and hedge fund managers may have started to believe that the 20% crash in oil prices since the middle of June could be over, and prices are set to go higher from here.      The largest U.S. oil stock-focused ETF, Energy Select Sector SPDR Fund (NYSEARCA: XLE), has seen traders reduce short interest by 14% in the past month, data from market analytics company S3 Partners cited by Bloomberg shows. XLE’s top stock holdings include the largest U.S. oil firms, such as ExxonMobil, Chevron, Occidental, ConocoPhillips, and EOG Resources. 

“ETF short sellers are actively trimming their short exposure -- possibly looking for a bottom in the market and removing some of their downside bets,” S3’s head of predictive analytics, Ihor Dusaniwsky, told Bloomberg. 

The recent trade moves suggest that many short sellers have cashed out after betting against the fund and that there is a possibility that others are buying the dip in oil, oil stocks, and oil-focused ETFs.

Energy stocks and oil-focused ETFs were top performers in the first half of 2022 when oil prices rallied to multi-year highs after the Russian invasion of Ukraine and the Western sanctions targeting Russian oil exports.  

But since the middle of June, international crude oil prices have slumped by 20% amid growing fears that the aggressive interest rate hikes from central banks, including the Fed, could lead to a recession in major developed economies. The uneven reopening in China amid sudden new lockdowns and mass testing have also spooked traders. 

Related: High Crude Prices Are Here To Stay

However, while the paper traded oil futures have been pricing in an economic slowdown or even a recession, the physical crude market remains tight as oil trade flows have changed in light of the sanctions on Russia. Uncertainty and volatility are high, and trading volumes are low in the summer, exacerbating the moves up and down for oil and oil stocks. 

Money managers started trimming long positions in crude oil and other petroleum futures after the markets began in mid-June, fretting about a looming recession. 

In the last weeks of June and the first week of July, money managers hastened to dump petroleum-related futures and options contracts, and they sold such contracts at one of the fastest pace since the pandemic in the week to July 5. Most of the trade moves in that week came from the liquidation of longs rather than the creation of shorts. 

The long-to-short positions in petroleum futures steadied in the week to July 12, with money managers buying the equivalent of 8 million barrels in the six most important petroleum futures, per data from commodity exchanges cited by Reuters market analyst John Kemp. In the four preceding weeks to July 12, hedge funds and other portfolio managers had been massively selling oil futures contracts. 

In a sign that the mass selling and shorting is over, for now, the latest reporting data for the week to July 19 showed a rise in the net long position—the difference between bullish and bearish bets—in Brent Crude

“Following the strength seen in the oil market over the early part of last week, it is no surprise that we saw speculators increasing their net long in ICE Brent over the last reporting period,” Warren Patterson, Head of Commodities Strategy at ING, wrote on Monday.

“The managed money net long grew by 15,164 lots over the last reporting week, to leave them with a net long of 154,792 lots. The move was fully driven by fresh buying, with the gross long increasing by 16,909 lots,” Patterson added. 

The latest trade moves in crude oil and oil-focused ETFs—with shorts cut and longs extended—suggest that the speculators and traders expect that oil has reached the bottom of the price move that began in June and that some of them are now buying the dip.  

Originally published by Tsvetana Paraskova for Oilprice.com

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