23 May 2023
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Oil investors tilting negative

Positioning reflects negative macro narrative more than oil fundamentals.

By Edward Bell

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Investor positioning in oil futures and options has turned resolutely bearish in the last several weeks, particularly in the Brent market. As a share of total open interest, speculative net length in Brent has fallen to less than 4% while the long to short ratio has dropped to just 2:1. Positions in WTI are holding up relatively better but still reflect a general negative attitude toward the outlook for oil in the near term.

Investors shortening their views on oil

Source: Bloomberg, Emirates NBD Research

The decline in net length has been borne in Brent markets both via cuts to long positions as well as increasing numbers of shorts being added. In the last month to May 19, net length has fallen by more than 127k lots thanks to a more than 61k build in short positions. Some shorts were cut last week, likely as oil prices have found a floor with Brent at around USD 75-76/b but the overall positioning still tilts negative.

The negative attitude toward oil is built on a macro narrative that the global economy is on the verge of a recession, that high interest rates will choke growth and perhaps, at a stretch, that oil’s function as an inflation hedge may be waning as inflation is under control. However, while economic activity in major economies is certainly slowing, it is still a reach to describe economies like the US as in recession: the composite PMI actually picked up to 53.4 in April, its strongest level since May last year and is predicted to print at similar levels for this month’s reading. Likewise, the Eurozone economy expanded in Q1—admittedly by a modest amount, but still not reporting a second quarter of contraction. Finally, China’s economy—which had been the missing piece in the global recovery last year—is emerging out of its Zero-Covid stupor with near-term indicators suggesting healthy, if not necessarily blistering, levels of activity.

Oil market specific indicators also still point to a tight H2 for 2023. US oil production has seemingly been capped around 12.1-12.3m b/d while E&P firms show reluctance to add rigs. The decline rate at major shale basins has also increased in the last several months, adding to the imperative to put more rigs to work to keep output stable, a challenge amid elevated funding costs. Russian production remains resilient as markets like China and India have been able to compensate for the loss of the EU as an export destination but Russia looks unlikely to be able to add production. And OPEC+ is now embarking on more production cuts, with output adjustments announced in April scheduled to have taken effect this month.

Our expectation for oil prices is that they will recover strongly in the second half of the year as a substantial tightening in oil markets emerge. We are maintaining that view even as markets look to non-fundamental macro headwinds (higher interest rates, the US debt ceiling). Moreover, investor positioning is basically at cyclical lows—the only lower level of net length in the last five years was during the peak of the Covid-19 pandemic. Therefore, there is room for positions to be added if oil prices show further signs of stabilization at current levels. We would also caution against putting too much heed to traders’ positioning: total open interest in Brent and WTI futures and options is at a low level relative to positions in the last five years, clouding its usefulness as a market indicator.

Total open interest in Brent and WTI has declined

Source: Bloomberg, Emirates NBD Research

Written By

Edward Bell Head of Market Economics


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