John Kemp, Reuters
The weakening outlook for oil consumption coupled with rising output from U.S. shale and softer than expected U.S. sanctions on Iran have convinced most traders the market is moving into a period of oversupply.
In the run up to December’s OPEC meeting in Vienna, hedge fund managers had little confidence in the organization’s ability to cut production by enough to avoid an oversupplied market next year.
Fund managers sold another 32 million barrels (MMbbl) of Brent futures and options in the week to Dec. 4, bringing total sales over the last 10 weeks to a record 360 MMbbl.
Funds now hold just over two long positions for every short one, down from a ratio of more than 19:1 at the end of September, and the least-bullish position for 17 months.
Bearish short positions have risen to 117 MMbbl, up from just 27 million at the end of September, and the largest number since June 2017.
Pessimism about the outlook for crude prices was reflected by a similar collapse in sentiment toward middle distillates such as gasoil. Fund managers sold another 20 MMbbl of European gasoil, bringing total sales in the last eight weeks to 82 MMbbl.
Funds are the least-bullish toward middle distillates since July 2017, according to an analysis of position data from ICE Futures Europe. Middle distillates are heavily geared toward the economic cycle because most distillate fuel oil is used in freight transportation (shipping, railroads, aviation, trucks), manufacturing, mining and farming.
So the collapse in sentiment toward distillates is consistent with growing concerns about the outlook for the global economy in 2019.
Investors’ fears about the impact of trade tensions and heightened uncertainty on business investment and growth next year is darkening the outlook for distillates just as it is hitting equity markets.
Expected oversupply of crude has been reflected in the sharp fall in Brent spot prices since the start of October and the futures curve swinging from backwardation into contango.
OPEC and selected non-OPEC countries agreed in early December to cut their output by 1.2 MMbbl per day during the first six months of 2019 from the level in October 2018. Most of the cuts will come from Saudi Arabia, with smaller contributions likely to come from Russia, the United Arab Emirates, Kuwait and Oman.
Other OPEC and non-OPEC countries are unlikely to reduce their output voluntarily by any significant amount so their participation in the agreement is mostly symbolic.
The planned production cuts reverse the OPEC+ group’s earlier ramp up in output and should offset the softer enforcement of U.S. sanctions on Iran.
By cutting output promptly and aggressively, OPEC+ may be able to avert a large build up in excess oil inventories next year and a collapse in prices similar to 2014-2015.
In contrast to 2014, Saudi-led OPEC has opted to sacrifice market share in an effort to defend prices at a higher level despite the rapid growth of U.S. shale.
But there is little the group can do about the deteriorating economic outlook, which implies the need for a period of lower oil prices to restrain production and stimulate consumption to keep the market balanced.
And as the global economy reels from the tariff war between the United States and China, rising interest rates, tightening credit conditions, and a broader economic slowdown, lower oil prices are a necessary part of the economic adjustment process.
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