Oil Investor Optimism at Post Slump High, Based on Faith in Cutback Compliance

Tuesday December 20, 2016

Even though verbal promises are so far the only assurance Organization of Petroleum Exporting Countries (OPEC) members – who are notoriously unreliable in keeping promises - will honour the deal to reduce oil production to a ceiling of 32.5 million barrels per day (bpd), money managers are betting compliance will happen as they increase their net-long positions.

U.S. Commodity Futures Trading Commission data shows that for the week ended December 13, hedge funds increased wagers on rising West Texas Intermediate by 2.5 percent, while bets on lower prices tumbled 30 percent to the lowest level since May; money managers also increased net-long positions in Brent crude by 25,276 contracts to 477,861, which Bloomberg points out extends the record in ICE Futures Europe data going back to 2011.

This is reportedly the most optimistic stance investors have taken since the price slump began over two years ago; "There's been a full embrace of the OPEC, non-OPEC deal," said John Kilduff, founding partner of Again Capital, adding, "The consensus is that supplies will tighten quickly, and as a result investors are positioning for higher prices in the near term."

But Tim Evans, an energy analyst at Citi Futures Perspective, stated the obvious when he reminded Bloomberg, "If OPEC doesn't adhere closely to the production cuts and supply exceeds demand in the first half of 2017, these money managers won't be happy."

Plus, money manager optimism doesn't change the fact that the cutback ratification seems to have buoyed U.S. shale producers, who in December will increase production to about 8.8 million bpd compared to 8.7 million bpd in July, according to U.S. Energy Information Administration projections.

Jim Ritterbusch, president of Ritterbusch & Associates, said in a note that these increases will undermine the OPEC cuts, "especially since we don't anticipate sustained strong compliance" from OPEC.

"While adherence to (OPEC) cutbacks could be quite high initially, we will be surprised by compliance much above 60 percent by the end of the first quarter, as (U.S.) shale responds to a higher-price environment."

Meanwhile, Brent on Monday lost 29 cents to settle at $54.92 a barrel, while West Texas Intermediate rose 22 cents to settle at $52.12 per barrel; this caused Phil Davis, managing partner of PSW Investments, to remark, "Nothing is really going on: the dollar is flat, oil is flat; it's a low margin Christmas trading week, we don't expect much to happen."

Nitesh Shah, commodities strategist with ETF Securities, is one of many experts who don't buy into the feel-good sentiments surrounding the OPEC cutback deal: he told CNBC in an email that, "Communication from OPEC is confusing: we are somewhat skeptical that cartel and the non-cartel members will stick to their production targets, and the market may have over-priced the extent to which inventories will fall next year."