Continued hedge fund liquidation of former bullish bets on oil and the establishment of new short positions have kept crude prices on the defensive over the last month.
Hedge funds and other money managers cut their bullish bets on crude oil by another 22mn barrels over the seven days ending on July 5.
Hedge funds have cut their net long position in crude futures and options by almost a quarter, from 633mn barrels to 485mn, over the last four weeks.
Hedge fund long positions have been cut by 77mn barrels from 769mn to 693mn barrels, according to the US
Commodity Futures Trading Commission and Intercontinental Exchange.
At the same time, short positions jumped by 72mn barrels from 136mn to 208mn barrels, as at least some managers anticipated the reversal in prices.
In the most recent week, most of the adjustment came from the short side of the market, where hedge funds increased short positions by 23mn barrels.
Hedge funds accumulated a record position in crude futures and options between the start of the year and the end of April.
Speculative positioning anticipated and helped accelerate the rebalancing of the oil market during the first half of the year.
But the concentration of positions created a substantial risk of at least a partial reversal once prices stopped rising (“Risks rise as hedge funds placed record bet on oil”, Reuters, May 3).
Benchmark Brent crude prices have fallen by more than $5 per barrel, 10%, over the last four weeks as positions have been liquidated.
There has been a close correlation between the accumulation and liquidation of hedge fund positions and the movement in crude oil prices since the start of 2015.
The correspondence between hedge fund short positions and the movement in US crude prices has been particularly pronounced.
Declining prices have been blamed on various factors including Britain’s Brexit referendum as well as concerns about slowing oil demand and an easing of supply interruptions.
In reality, momentum trading, with traders chasing ever-rising prices, was an important contributor to the rise in oil prices between January and May.
Once the momentum was broken, it was highly likely prices would pull back somewhat as traders sought to lock in past gains.
By late May and early June, it was clear the upward momentum in prices had stalled and the risk of reversal began rising.
Hedge funds still have a relatively large net long position in crude oil futures and options, even after the recent wave of selling, so the current liquidation cycle could still have some way to run.
But the underlying supply-demand balance has tightened significantly since the start of 2016 as a result of continued consumption growth and the impact of supply disruptions and investment cutbacks.
Most analysts now see the market close to balance throughout the remainder of 2016 and 2017 with price risks tilted to the upside towards the end of the period.
The tightening outlook for the supply-demand balance over the next 2-3 years should provide some support for oil prices even if hedge funds continue to cut their positions in the near term.
Nearly all the weakness in oil prices has been concentrated in nearby futures and options contracts, where most hedge fund positions are concentrated, while prices for contracts in 2018 and beyond have held steady.
The price of the Brent calendar strip for 2018 has fallen by just $1 per barrel over the last four weeks while the calendar strip for 2019 is basically unchanged and the strip for 2020 has actually risen by 50 cents.
Provided the US
and global economies avoid a recession, the rebalancing process is set to continue, which should limit the near-term downside for oil prices and point to further increases between 2017 and 2019.

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

Deutsche Boerse lowers key hurdle for merger with LSE
Approval threshold cut to 60% from 75%; acceptance period extended to July 26; Brexit vote threatens to disrupt deal

Reuters
London


London Stock Exchange Group and Deutsche Boerse have agreed to lower the level of approvals they need from the German exchange’s investors to push through their planned merger.
The companies have reduced the approval threshold to 60% from an earlier minimum of 75% as they try to keep the merger on track following Britain’s vote to leave the European Union and concerns from Germany’s markets regulator.
“This change in procedure is a purely technical one.
We are confident that we will reach the 75% threshold in the course of the full tender process,” Deutsche Boerse CFO Gregor Pottmeyer said yesterday.
Financial regulators in Germany and Britain, along with European Union antitrust authorities, are likely to pose a sterner challenge to the $27bn merger.
German markets regulator BaFin last month said it was hard to see how the head office of the merged group could be in London given that Britain was leaving the European Union.
Deutsche Boerse said on Sunday it was concerned that the 75% threshold might prove difficult to secure because index funds which hold up to 15% of its shares are unable to accept the offer until the minimum level of acceptances has been reached.
“The fact that Deutsche Boerse is considering lowering the threshold leads us to believe the vote could be much closer than that of LSE’s 99% approval,” Keefe, Bruyette & Woods (KBW) analysts wrote in a note.
Shareholders in the British company approved the plan at a subdued, short meeting last week despite uncertainties after the EU referendum result.
Deutsche Boerse had asked its shareholders to back the deal — the third attempt by the LSE to merge with the German exchange operator in some 16 years — in a postal vote that had been due to close on July 12.
However, the acceptance period is being extended for a further two weeks to July 26.
Terms of the deal cannot be changed until the merger closes around the end of June next year.
Deutsche Boerse and LSE officials have signalled they are willing to do whatever it takes to get the green light from regulators.
The two companies are looking at how they could reassure regulators that a merged company would actually implement any structural changes such as the location of the head office agreed before the deal closes.
A source familiar with the process said one idea would be for a legal undertaking to regulators, similar to a “living will” banks must now write for regulators, setting out what would happen if it got into trouble.
Shares in LSE were up 2% at 2,623 pence at 1320 GMT.
Deutsche Boerse’s stock was also up 2%.
Up to Friday’s close, LSE shares had fallen about 6% since the Brexit referendum but were still up more than 11% from their close the day before the deal was announced.