Financial Pressure Puts Oil Prices on Edge

Oil price benchmarks may come under downward pressure in the coming weeks from large financial positions in both ICE Brent and Nymex West Texas Intermediate (WTI). Traders fear that large concentrations of put options on oil futures -- which give the right to sell at an agreed price -- could create an avalanche of sales on oil exchanges. These positions are especially large in Brent through the end of April and in WTI in the first two weeks of May. “This is not a good sign for the bulls,” said one oil broker, adding the market is relatively stable but softening. June Brent futures closed the week down $1.91 at $62.95 per barrel, with the general consensus citing worrisome supply and demand fundamentals (related). Brent hit $70/bbl in mid-March but that rally ran out of steam (OD Mar.19'21). Speculators are not coming back to market to bet on higher prices before they know “how these puts are impacting the market,” the broker notes. Without "longs" willing to step in, sellers find fewer parties willing to buy, exacerbating the impact of the sale. Brent has around 25,000 put contracts at $60/bbl that expire on Apr. 30. To cover the risk, sellers of these puts need to sell oil futures contracts, but by selling they push oil closer to the strike price of the option and are then forced to sell even more -- a process known as the "magnet pull" of options. Brent also has some 25,000 contracts outstanding on $55/bbl and around 20,000 contracts apiece for $50, $45, and $40/bbl, all of which expire on Apr. 30 as well. Similar volumes are outstanding in WTI at strike prices of $40-$55/bbl with a May 17 expiration. So Long Since mid-March, banks and funds have sold 38,000 long positions, 11% of the holdings, but also stepped out of 6,000 shorts that make money when the oil price falls -- a drop of 15% and a sign that risk capital is lowering its exposure to oil, even though oil remains quite popular (OD Mar.26'21). In the week ended Apr. 6, long positions sold 22,000 contracts, the US Commodity Futures Trading Commission said Friday. But the long/short ratio is still high at nearly 12:1, with 395,000 contracts betting on higher prices and 34,000 on lower prices. Banks and funds make up only 14.5% of all open positions in the WTI crude contract on Nymex, but they have an outsized impact on oil prices as they create price swings and exacerbate price trends by pushing risk capital in and out of contracts. Icap-TA, which tracks the oil market via technical analysis, notes that bets on higher prices were first attracted by February’s freeze freeze in Texas that shut in large swaths of oil production and refining operations, and then by the blockade of the Suez Canal, which halted the flow of oil and products (OD Mar.29'21). Both events were “clickbait” for speculators entering “the seasonal peaking window of an amply supplied petroleum market,” writes Icap’s Walter Zimmermann, who noted that the influx has been followed by “continued long liquidation.” Don’t Go That dynamic makes it difficult for hedgers to find counterparties. “The drop in open interest complicates efforts by banks and other organizations to help producers hedge future production,” says energy economist Phil Verleger in his publication, Notes at the Margin. When producers sell their production forward, they need a "long" position in futures contracts to buy the oil -- to take the other side. This can be a speculator or a consumer like the airline industry. Verleger argues it has been challenging to find buyers, especially after the airline industry left the market due to Covid-19. Banks publishing bullish notes -- like Goldman Sachs predicting $75/bbl oil at the end of the year -- is an attempt, Verleger notes, “to attract new investors or convince existing investors and speculators long on oil not to close their positions.” John van Schaik, New York