Stocks and bonds are out, and oil is in. That has become the new playbook for many hedge funds this year as they try to navigate rising interest rates, persistent inflation, and a tech-heavy equity market that remains deeply out of favor. After initially building large positions in the oil markets, hedge funds had been trimming their positions as oil prices tumbled thanks to weak demand and a surplus gradually building during the second half of the year. By August, open interest, or the total number of West Texas Intermediate (WTI) futures and options contracts that had not been settled, had declined 26% Y/Y to 2.3 million contracts.
Luckily, OPEC+ has just gifted the bulls a new lifeline. The cartel’s decision to cut production by 2 million barrels in November has revived the oil price rally, and hedge funds are rushing back in. According to Reuters, hedge funds and other money managers purchased the equivalent of 62 million barrels in the six most important petroleum futures and options contracts in the week ending Oct. 4th.
Funds are buying far more crude crude (+46 million barrels) than fuels (+15 million), with the uptick in buying activity coming after the OPEC+ announcement, according to Reuters market analyst John Kemp.
Money managers purchased 27 million barrels of Brent, 19 million barrels of NYMEX and 19 million of ICE WTI. On the distillates front, portfolio managers bought 6 million barrels of European gas oil, 6 million barrels of U.S. diesel and 4 million barrels of U.S. gasoline, Kemp writes.
The combined crude position has now climbed to 360 million barrels, good for the 18th percentile for all weeks since 2013, up from 314 million barrels the previous week. Meanwhile, the combined distillate position increased to 56 million barrels, good for the 45th percentile, from 45 million recorded the previous week.
Oil prices have been pulling in the current week after exploding more than 13% higher last week after data from China raised concerns about demand from the world’s largest crude importer.
Front-month Nymex crude for November delivery settled -1.6% to $91.13/bbl, snapping a five-session winning streak while December Brent crude ended -1.7% to $96.19/bbl. Front-month Nymex natural gas for November delivery finished -4.6% to $6.435/MMBtu, tumbling to its lowest level in nearly three months with rising production seen tipping the market out of balance.
Another bearish factor: fears the Federal Reserve will continue tightening in a bid to rein in inflation have been strengthening the dollar while hurting oil prices, equities, and other dollar-based commodities.
However, it’s likely that oil prices won’t fall very far with OPEC+ demonstrating a willingness to take drastic measures to goose prices. Indeed, Eurasia Group’s Raad Alkadiri has told Barron’s that, “They are willing to take proactive measures at a higher price than might have been seen in the past,” and that ‘‘OPEC+’s idea of market balance is at $90-$100.”
OPEC+ says its decision is a matter of getting ahead of global economic weakness that will cause oil demand to fall and end up hurting prices. Alkadiri has also noted that Crown Prince Mohammed bin Salman is currently undertaking expensive public works projects, ironically including massive green projects, and more oil revenue will be needed to fund those projects. Indeed, Saudi Arabia appears much less worried about losing market share than in the past, while U.S. producers have been raising production only slowly as they seek to satisfy investors who would rather see money spent on dividend payouts and buybacks rather than on drilling new wells.
However, Commerzbank analysts have predicted that OPEC+’s production likely will “decline by only 1M barrels because many countries are already producing well below quota,” although “this would still be enough to prevent the surplus that has been predicted for the final quarter of this year.“
It’s going to be interesting to see how the Biden administration will respond to OPEC+ attempt to keep oil prices permanently high. President Joe Biden has condemned the move and has vowed to “consult with Congress” on ways to “reduce OPEC’s control over energy prices.”
Back in May, the U.S. The Senate passed the No Oil Producing and Exporting Cartels (NOPEC) bill intended to protect American consumers and businesses from engineered spikes in the cost of gasoline and heating oil, despite some analysts warning that it could also have some dangerous and unintended consequences.
The bill would change U.S. antitrust law to revoke the sovereign immunity that has long protected OPEC and its national oil companies from lawsuits, giving the U.S. attorney general the ability to sue the oil cartel or its members in federal court. However, it remains unclear exactly how a U.S. federal court could enforce judicial antitrust decisions against foreign nations, not to mention that other countries could retaliate by taking similar action on the United States, for example for withholding agricultural output to support domestic farming.