Hedge funds and other money managers were turning increasingly bearish towards oil even before prices plunged on Thursday.

Hedge funds cut their net long position in the three main futures and options contracts linked to Brent and WTI by 97 million barrels in the week to May 2.

Bullish long positions were trimmed by 31 million barrels while bearish short positions increased by 65 million barrels according to data published by regulators and exchanges.

Hedge funds reduced their net long position by a combined 236 million barrels over the two weeks between April 18 and May 2.

Fund managers now have the smallest net long position in crude futures and options since OPEC announced its production-cutting deal on Nov. 30.

Fund managers hold just three long positions for every one short position, down from a ratio of almost 6:1 on April 18 and a recent high of 10:1 on Feb. 21.

The ratio was also the lowest since the OPEC deal was announced and illustrates the loss of confidence in the deal’s effectiveness in draining global inventories.

Bearishness is not confined to crude. Fund managers have also turned increasingly negative on the outlook for the price of refined fuels given the high level of stockpiles in the United States.

Hedge funds cut their net long position in NYMEX gasoline by 24 million barrels in the week to May 2 and are now running a small net short position of 3 million barrels for the first time since August 2016.

Hedge funds also cut their net long position in NYMEX heating oil by 26 million barrels and are now net short by almost 1 million barrels, the first short position since November 2016.

PRICE MOVES

The liquidation of hedge fund positions followed by a sharp drop in oil prices is consistent with empirical and theoretical work on price dynamics.

Significant liquidation often starts before a sharp drop in oil prices (“Why stock markets crash: critical events in complex financial systems”, Sornette, 2003).

The initial liquidation is orderly but accelerates as more and more position owners rush for the exit at the same time (“Predatory trading and crowded exits”, Clunie, 2010).

Pierre Andurand, one of the most prominent bullish hedge fund managers in oil, reportedly liquidated his last remaining long positions during the final week of April, before the price rout on May 4 (“Oil bull Andurand closes bet on rally”, Reuters, May 5).

Given the further sharp decline in oil prices it is very likely hedge fund managers have cut their net long position even more since May 2.

The elimination of so many long positions has left the oil derivatives market looking more balanced than at any time since November, which could ease some of the downward pressure on prices.

And short positioning has also increased to a relatively high level of 263 million barrels across Brent and WTI which leaves the market vulnerable to a short-covering rally.

Overall, hedge fund positioning in oil now appears neutral. What happens next, whether the funds turn bullish again or become more bearish, depends largely on what happens to oil inventories over the summer.

Source: Reuters (Editing by Edmund Blair)