Benchmark crude prices have risen almost 8% since early last week in what has all the hallmarks of a short-covering rally. Brent futures for October have risen by more than $3 per barrel from a low of $41.80 on August 2 to over $45 in trading earlier yesterday.
WTI futures for October delivery have risen by $3 per barrel over the same period from $40.30 to $43.30.
Hedge funds and other money managers accumulated a substantial number of short positions in crude oil and gasoline over the nine weeks since the end of May.
Hedge funds had amassed short positions in Brent and WTI equivalent to 374mn barrels by August 2 (the latest day for which data is available), the highest number since the middle of January.
The number of short positions in the three major Brent and WTI contracts has more than tripled since the end of May when it stood as low as 104mn barrels.
There has been comparatively little change in hedge fund long positions over the same period.
Longs were cut from 743mn barrels to as little as 691mn but have recently been boosted back to 714mn.
The past nine weeks have seen the fourth hedge fund short-selling cycle in WTI since the start of 2015 and a corresponding decline in WTI prices.
But the price drop has been smaller than during previous short-selling cycles, given a similar accumulation of short positions, which is probably due to the persistence of long positions.
Hedge funds with a more bullish outlook on oil prices have chosen to maintain or even add to their long positions in WTI rather than liquidate them, limiting the price slide.
The concentration of hedge fund short positions has left prices vulnerable to a sharp reversal in the event that prices stop sliding or hedge funds try to lock in some of their profits.
Hedge funds have added an extra 178mn barrels of shorts in WTI since the end of May. The total short position of 248mn barrels is only 13mn barrels below the record of 261mn set in November 2015.
In Brent, hedge fund short positions have increased by 90mn barrels to 125mn barrels, which is only 32mn barrels below the record short position of 157mn barrels set in September 2014. Hedge funds’ ultra-bearishness towards oil extends well beyond the crude market.
Hedge funds have also added nearly 16mn barrels of short positions in NYMEX gasoline futures since the end of May.
Hedge funds have established an extremely rare net short position in NYMEX gasoline, amounting to 4mn barrels, for only the fifth time since 2006.
Hedge fund short positions in gasoline amount to 42mn barrels, the largest number of shorts since January, and only 9mn barrels below the record of 52mn set in November 2015.
By August 2, hedge fund short positions across the crude and products complex were beginning to look over-extended.
Anything that caused prices to rise, or just break the momentum behind the price falls, was likely to trigger a fierce short covering rally.
Data on how hedge fund positions changed in the second half of last week will not be published until this coming Friday.
But it seems likely they will show a reduction in short positions and/or increase in longs coinciding with the sharp price increase.
Some hedge funds seem to have anticipated a bout of short covering, which is probably why many clung on to long positions and did not liquidate them despite the drop in prices.
In fact, hedge funds have boosted their combined long positions in NYMEX and ICE WTI in each of the last five weeks by a total of 20mn barrels, apparently anticipating a reversal.
Long positions in Brent crude have also risen in each of the last two weeks by a total of almost 10mn barrels.
The rally has no doubt been fuelled by the forthcoming informal meeting of ministers from the Organisation of the Petroleum Exporting Countries in September and the possibility of another attempt to coordinate output cuts.
There are good reasons to treat discussions about the meeting with extreme caution. The ratio of Opec meetings to Opec output cuts is very high.
So far ministers have repeated bromides about monitoring market developments and given no indication a serious effort to reach an output agreement is underway.