John Kemp is a Reuters market analyst. The views expressed are his own.

By John Kemp
London


Hedge funds have unwound most of the record short position they established in US crude futures and options between June and August amid signs that the oil market is rebalancing.
Hedge funds and other money managers had cut their gross short position in the main NYMEX WTI futures and options contract to 90mn barrels by October 13.
Reported shorts had been reduced from 108mn barrels the previous week and a peak of 163mn barrels in early August, according to the US Commodity Futures Trading Commission.
Fifty-seven hedge funds were still running reported short positions last Tuesday, down modestly from a peak of 66 in August.
But the average short position of those who remain has been almost halved to 1.58mn barrels, down from 2.86mn.
Hedge funds have become much less aggressive in shorting US crude as the previous downtrend has stalled and amid signs that supply and demand are beginning to rebalance.
The perceived balance of risks has shifted significantly over the last six weeks and hedge funds have reacted by trimming their short positions.
Goldman Sachs, among the biggest bears, has acknowledged “there are growing signs of a supply side adjustment and rebalancing taking place” though the bank warns about become bullish too soon (“Oil Gauge: On the road to rebalancing, but patience needed” Oct ober 14).
Barclays is blunter. “Current price levels are not nearly high enough to encourage production over the medium term” the bank warned and “prices need to move higher than what the oil futures market is currently pricing in, or there will not be enough supply”.
The number of rigs drilling for oil in the US fell by 10 last week to 595, according to Baker Hughes, and has fallen by a total of 80 in the last seven weeks, as US shale drillers struggle to cope with prices well below $50 per barrel.
Oil production from the four largest shale plays is forecast to decline 93,000 barrels per day (bpd) in November, the biggest monthly decline to date, according to the US Energy Information Administration.
Total output from the Bakken, Eagle Ford, Niobrara and Permian plays will have fallen 430,000 bpd from its March peak (“Drilling Productivity Report” October13).
There are increasing reports of financial distress among US exploration and production companies as well as the shale drilling firms themselves as banks trim their credit lines and the rating agencies downgrade their debt.
On the demand side, there is clear evidence of higher fuel consumption in the US and other advanced economies, as well as India and China, in response to continued economic recovery and lower prices. With the adjustment process still in its early stages and US crude inventories rising, few hedge funds are willing to risk adding to their outright long positions.
Money mangers’ long positions in NYMEX WTI have increased by just 11mn barrels since early August while short positions have been cut 73mn. But the risk-reward ratio for shorting the US oil price has become much less attractive, which has in turn taken some of the heavy selling pressure out of the market.