Hedge fund positioning in oil had become directionless in the run-up to last week’s sell-off, after a four-month rally since the first successful COVID-19 vaccines were announced at the start of November.
Hedge funds and other money managers purchased the equivalent of just 12 million barrels in the six most important petroleum futures and options contracts in the week to March 16.
The combined position (913 million barrels) was virtually indistinguishable from the position four weeks earlier on Feb. 16 (904 million barrels), according to records published by exchanges and regulators.
In contrast, positions had climbed by 548 million barrels over the previous 15 weeks, an average of more than 36 million barrels per week.
Fresh fund buying seems to have dried up when front-month Brent futures prices climbed above $65 per barrel – a level that has been sufficient to increase U.S. shale production over the last decade.
The most recent week saw small-scale buying in NYMEX and ICE WTI (+3 million barrels), U.S. gasoline (+7 million), U.S. diesel (+3 million), and European gas oil (+5 million) but minor sales in Brent (-6 million).
Between early November and the middle of February, hedge fund buying helped accelerate, and probably exaggerate, the recovery in prices, anticipating a re-opening of service sector businesses and resumption of international air travel.
However, once prices had passed the mid-$60s, there was a growing risk of overshooting, which limited further buying and ultimately created conditions for a short-term correction, which occurred later last week.
Over the last 10 years, U.S. shale production has consistently increased whenever prices are much above $60 per barrel and captured market share from OPEC whenever prices are over $65.
In a sign of revival within the U.S. shale industry, the number of rigs drilling for oil in the United States has already climbed to 318 from its low of just 172 in August.
The current increase in drilling is following a broadly similar trajectory to the resumption of drilling activity after slumps that troughed in May 2016 and May 2009.
Prices in the $70-80 range would likely have accelerated the resumption of drilling even further, threatening to erode OPEC+ market share later in 2021 and especially in 2022, making prices very unstable in this range.
At the same time, slow progress with coronavirus vaccinations and an increase in the number of infections in Europe threatens to delay the re-opening of international air travel in the second half of 2021, dampening the expected recovery in jet fuel consumption.
With production rising, consumption seen weaker, and no new fund buying to steady the market, oil prices were primed for a correction – which arrived with a 7% one-day decline on March 18.