Hedge funds turn strongly bullish on oil markets

By John Kemp

LONDON, March 8 (Reuters) -- Hedge funds have switched from a very bearish view on crude oil prices at the end of last year to a much more bullish one, especially for Brent.

Such funds and other money managers had amassed a combined net long position in the three main contracts on NYMEX and ICE amounting to 445 million bbl of crude by March 1.

The combined net long position in West Texas Intermediate (WTI) and Brent futures and options was boosted by more than 61 million bbl last week to the highest level in nine months.

The combined net long position has risen by more than 200 million bbl since the start of the year, according to data from the US Commodity Futures Trading Commission and ICE Futures Europe.

Hedge funds have much larger bullish positions in Brent than WTI. They hold a net long position of 342 million bbl in Brent compared with 102 million bbl in WTI.

Hedge funds added 16 million bbl to their long positions in Brent over the week to March 1 while cutting the small number of remaining short positions by almost 6 million bbl.

The preference for holding bullish positions in Brent reflects lingering concerns about the availability of storage space for surplus oil in the US.

It is also much cheaper to hold bullish positions in Brent because the contango in the Brent contract is much narrower than in WTI.

In a contango market, it costs money to maintain a long futures and options position by rolling expiring contracts forward (whereas someone with a short position will be paid for rolling their position).

With the contango in Brent much narrower than in WTI, it costs less to maintain a long position, while waiting for spot prices to rise is lower than executing the same strategy in WTI.

But while the biggest long positions are still in Brent, the largest change in positions last week was in the WTI contracts, where hedge funds slashed their short positions.

Combined short positions in NYMEX and ICE WTI were cut by a massive 38 million bbl, 15%, in a single week, from 249 million bbl to 211 million.

US crude prices have corresponded closely with the accumulation and liquidation of hedge fund short positions in WTI since the start of 2015.

As expected, the liquidation of hedge fund short positions was associated with a big rise in WTI prices, from under $32/bbl to almost $34.50.

Prices have continued rising strongly and are now over $36.50/bbl, which strongly suggests liquidation of hedge fund short positions has continued since March 1.

The big price rise marks the third time since the start of 2015 that there has been a large short-covering rally as hedge funds amass and then exit from large short positions in NYMEX WTI.

The price move on WTI can be dismissed as the unwinding of short positions but the record long in Brent suggests many hedge funds are now betting on a big rise in oil prices in the rest of 2016.

Signs of financial distress across much of the oil industry, coupled with data showing production outside OPEC falling, continued market chatter about an agreement among producers, and evidence of strong demand for gasoline, have allowed hedge funds to construct a more bullish narrative.

Previous rallies in March-May and August-October 2015 ran out of steam and saw prices fall back to new lows.

But for now, the hedge funds are in control and again bullish. Just as they helped drive prices up sharply twice last year, then sent them tumbling, they are in a bull phase again.