Oil rally is not just about hedge funds

01/05/2016 05:19 AST

Oil prices are becoming dangerously overheated as speculators anticipate a rebalancing of supply and demand that has barely started, according to many oil analysts.

“Even as oil rallies, analysts have barely nudged up their price forecasts as they worry that crude’s recent gains might not be sustainable,” notes the Wall Street Journal (“Analysts just aren’t buying the oil rally,” April 28).

Many fear hedge funds are pushing up oil prices prematurely, which will lead to a renewed crash when the bubble bursts, as it did after the last big run-up in prices between January and May 2015.

Hedge funds and other money managers have accumulated a record net long position in Brent and WTI futures and options, betting on a further rise in prices equivalent to 656 million barrels of crude.

The net long position has surpassed previous peaks set this time last year (572 million barrels) and before that in June 2014 (621 million) as Daesh terrorists were racing across northern Iraq and just before prices started to crash.

Since the start of 2015, there has been a close correspondence between the accumulation and liquidation of hedge fund positions and short-term movements in oil prices. The colossal net long position has increased the risk of a reversal in prices if the rally were to run out of momentum and hedge funds were to begin liquidating some of their positions. Stockpiles of crude oil and refined products in the US and around the world are running at record levels and still increasing, albeit more slowly than a year earlier.

By most estimates, oil production is still running ahead of consumption, although the imbalance has narrowed and could reverse in the second half of 2016 or early 2017. In the short term, prices have been supported by temporary supply interruptions in Nigeria, Libya and Iraq that may not last.

And even if the market rebalances and moves into a small deficit, it could take several quarters for the enormous overhang of crude and product stocks to fall to more normal levels. So there are plenty of reasons to be cautious about the sustainability of the current rally and worry that it will run out of steam.

But it would be wrong to assume the run-up in prices was being driven entirely by trend-chasing and macro-focused hedge funds.

Fundamentals are clearly improving on the supply and demand sides of the market and it is now possible to identify a trajectory that will bring production and consumption back to balance.

SUPPLY AND DEMAND

Gasoline consumption in the US is apparently on track for another year of exceptionally strong growth in 2016.

Consumption has been steadily revised up from a predicted increase of just 10,000 barrels per day (0.1 percent) in December to 130,000 bpd (1.4 percent) in April.

Road traffic is growing strongly and shows no sign of levelling off. Volumes were up 5 percent in February compared with a year earlier and have shown consistent growth averaging around 3.5 percent in recent months.

Vehicle buyers are increasingly choosing larger and more fuel-hungry sport-utility vehicles and especially crossover-utility vehicles rather than smaller, more energy-efficient cars. Car sales as a proportion of all new-vehicle purchases have dropped from 52 percent in 2009 to 44 percent in 2015 and are forecast to slide to just 41 percent in 2016, according to industry analytics firm Wards Auto.

The balance is made up of sport-utility vehicles, pick-ups, light vans and especially crossover-utility vehicles, which are the fastest-growing segment of new vehicle sales. Similar trends are evident in India and China. Traffic is growing strongly and car buyers are opting for larger and more fuel-hungry vehicles, leading to rapid growth in gasoline consumption.

In contrast to gasoline, consumption of middle distillates used as diesel and heating oil has stagnat

Arab News