Financial Markets: Risk Capital Swings on Oil's Mood, Bullish on Macro

Copyright © 2021 Energy Intelligence Group
Is Oil Market Psychology Shifting?

The falloff in the front-end Brent price curve has caught the market by surprise and created confusion. Despite a healthy structural backwardation, the Brent flat price has dipped $5 per barrel from its recent $76.33/bbl high on Jul. 30. The Delta Covid-19 variant has spooked the market and prompted a fair bout of speculative liquidation and profit taking. The forward market continues to signal tightness, but the large swings in risk capital are casting doubt over the reflation trade, which reflects expectations of higher oil prices from strong economic growth and hence speculators’ outlook on future demand growth (related). So far, there has been little evidence that reflationary trades in commodities were being unwound. The big swings in risk capital committed to market seems mostly from speculative funds that ride short-term waves. This hot money, trying to benefit from a price swing, has cooled off some after Brent fell below $69, from $75 at the start of August. Yet, volatility has encouraged capital to switch from “buy the dip” to “sell the rise” quite easily, which tends to keep prices on a roller-coaster ride and within a narrower $70-$75 trading range. As backwardation flattens at the front of the price curve, so does the immediate appeal of oil futures with passive money, mostly because rolling future contracts every month becomes less profitable when the time spreads narrow. The profit from these trades has halved in recent weeks. In July the Brent crude futures price curve showed an average front-month premium of $4.04/bbl over crude for delivery six months later, which has narrowed to $2.20, but still signals that crude oil is in tight supply. The corresponding time spread for West Texas Intermediate (WTI) crude futures averaged $4.43/bbl in July, which has narrowed to $1.80. But for all the fluctuations, the size of speculative long positions -- or bets on higher prices -- remains much larger than the size of shorts -- or bearish price bets. Data from the US Commodity Futures Trading Commission show that money managers' long positions in WTI exceed short positions by a ratio of 10-13 early August, up from 8-1 late July. In comparison, speculative length in Brent futures has moved to five bets on higher prices versus one bet on lower prices in early August from 4-1 in the second half of July (OMI Jul.19'21). Regulator data shows that the number of bullish price bets have returned to their levels at the start of the year. But the value they represent is nearly 50% higher at $47 billion, as oil prices started the year at just $52/bbl. Demand and the resulting product draws in the US and Europe have been generally supportive of firmer forward prices, especially for gasoline, naphtha and fuel oil. The US Nymex RBOB and Europe Amsterdam-Rotterdam-Antwerp EBOB futures are in backwardation until February 2022, mirroring the strong rebound in regional gasoline demand, which is mostly back to its 2019 levels. Diesel is falling out of favor (OMI Jun.16'21). In the Mediterranean, the gasoline forward curve is in backwardation until December 2021. Likewise, the European and Japanese forward naphtha curves are showing a steady backwardation until well into 2022, and so does fuel oil futures across the main Houston, Rotterdam and Singapore bunkering hubs.

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