Forget OPEC, this is the real reason why the oil price is going down

Russ Mould
13 November 2018

“In the short term money flows can overwhelm more fundamental considerations – or to paraphrase Benjamin Graham, in the short term the market is voting machine and in the long run it is a weighing machine – and a classic example of this right now might be oil,” says Russ Mould, AJ Bell investment director.

“While OPEC continues to jawbone about supply and demand ahead of its next bi-annual meeting in Vienna on 3 December and analysts continue to follow US shale output and US inventories as potential wildcards, since both are beyond OPEC’s influence and both are currently rising, the real driver of oil right now looks to be financial speculators – in other words, money flows.

“Fundamentals such as supply and demand will ultimately prevail – and the OPEC cartel clearly has an influence on supply since it produces around a third of the globe’s daily oil requirements – but they can be drowned out in the short term by speculation, as traders (using leverage, or borrowed cash, to try and maximise returns) move in and out of positions via the futures markets.

“Data from the CME Group shows that in the summer, gross short positions against oil reached a record low of just 53,133 contracts in August.

Source: Refinitiv data

“In other words, hardly anyone was expecting the oil price to fall. By contrast, long oil futures contracts reached a record 871,954 in January as traders punted (correctly) on a higher oil price. That made for a record net long position of 784,290 contracts.

“Since then, the longs – or bulls – of oil have been quietly selling to lock in their profits, while short activity has picked up from those record lows, as traders have begun to actively bet on a retreat in the price of West Texas Intermediate oil.

“These fund flows – less buying and a lot more selling - look to be influencing oil which is now in bear market territory, more than 20% below its summer peak.

Source: Refinitiv data

“Saudi Arabia and the other OPEC members, as well as Russia, will now be looking to wrest back the initiative on 3 December and hence Riyadh’s hints about production cuts as the kingdom expresses concern over demand and doubtless notes the inexorable rise of US shale output.

“Trend output growth from America’s shale fields of around 20% to 30% year-on-year in the second half of 2018 has led to a renewed increase in US crude oil inventories and traders may be waiting for a shift in momentum here before they become more bullish on oil, perhaps reversing the recent move to go short, or at least lessen long positions on the commodity.”

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