(John Kemp is a Reuters market analyst. The views expressed are his own)
By John Kemp
Hedge funds have become strongly bullish on the outlook for all parts of the petroleum complex, amid signs global crude stocks are declining and fuels will be short supply after hurricane-related refinery outages.
But with so many fund managers already betting heavily on a further rise prices, the market has become lopsided and the risk of a sharp reversal has increased significantly.
Hedge funds and other money managers raised their combined net long position in futures and options linked to Brent and WTI by 83 million barrels in the week to Sept. 19.
Fund managers have amassed a net long position amounting to 695 million barrels, the highest since mid-August and before that late April, in a clear sign of returning confidence.
The net long position in Brent rose by 34 million barrels to 465 million, the highest for six months, according to records published by regulators and exchanges.
Meanwhile, the net long position in WTI increased by 49 million barrels to 230 million, the largest one-week rise since December 2016.
Portfolio managers also increased their already large net long position in U.S. gasoline by a further 3 million barrels to 71 million, the highest since April 2014.
The net long position in U.S. heating oil rose by a further 5 million barrels to 51 million, the highest since February 2013.
And the net position in European gasoil was boosted by 0.2 million tonnes to a new record of 17.2 million tonnes.
Fund positioning in gasoline, heating oil and gasoil now looks very stretched, with the ratio of long to short positions near multi-year highs in each case.
The large concentration of hedge fund long positions in gasoline, heating oil and gasoil could presage a sharp correction at some point if fund managers try to realize some of their profits.
From a fundamental perspective, stocks of gasoline and especially middle distillates look somewhat tight as winter approaches in North America and Europe.
But refining margins for making gasoline and diesel are now very high, providing a strong incentive for refiners to minimize maintenance and maximize processing in the next few months.
And refinery owners are likely to respond by processing seasonal record volumes of crude over the next few months which should cut the risks of shortages.
With so many hedge funds now long, the trade is starting to look crowded, and the balance of price risks has shifted to the downside for all the refined fuels.
Hedge fund positioning in Brent and especially WTI is less lopsided, with net positions and ratios in both crudes well below the peaks set earlier this year.
Intensive refining activity over the next few months as refiners try to stabilize and rebuild fuel stocks should ensure strong demand for crude.
But even for crude, the balance of risks is starting to shift, with positioning and prices suggesting oil is no longer oversold, even if prices do not appear excessive yet.
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