Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Every week, the Commodity Futures Trading Commission publishes its "Commitment of Traders," or COT report. The section on oil would be better described as the NOT report right now.

On the face of it, the chart below looks pretty bullish for crude:

Short Stop
Hedge funds' net short position in light, sweet crude oil futures and options has come in from the very bearish low point it reached at the beginning of March
Source: Bloomberg

Speculators seem to be emerging from their winter gloom. Look beneath the net number, though, and their enthusiasm for oil looks thin. This is a case of "Non-Commitment of Traders".

Do You Really Love Me?
Non-commercial long and short positions in light, sweet crude oil versus the oil price, indexed
Source: Bloomberg

Notice how, apart from a brief run up in December and January, hedge funds' long positions in crude oil -- the blue line -- have held pretty steady over the past year. The three rallies in oil -- last spring, fall and right now -- have all been fueled by big drops in short positioning. In plain terms, those betting against oil have periodically lost their nerve and covered their positions, pushing the price higher. Right now, they may be focused on the possibility of action by OPEC and Russia to freeze production, however vague and imperfect, or seasonally strong U.S. gasoline demand.

Given that speculators tend to play overwhelmingly in near-dated oil contracts, this likely explains why the front end of the curve has rallied more sharply, as you can see here:

Nearest and Dearest
The oil curve has flattened out since February's market trough, as near-dated prices have risen faster
Source: Bloomberg

This should cause at least some nagging doubts for oil bulls. Wednesday's weekly report from the Energy Information Administration showed another big slug of crude oil flowing into U.S. storage tanks that are already pretty full. Even a big draw in gasoline inventories left them "well above the upper limit of the average range," in what has become a cut-and-paste refrain from the EIA.

On that front, the flattening of the futures curve may contain the seeds of its own destruction. What keeps oil stored in tanks is a big fat spread between cash prices and those further out in time. When that gets squeezed, the cost of storing oil and financing this carry trade can make it uneconomic to keep doing it -- so the inventory gets pushed back into the market. And those extra barrels help push down the cash price again.

Here's the other problem with those higher futures prices: They allow struggling exploration and production companies to lock in cash flow and stave off the day their output -- or their whole company -- collapses. But, you might ask, who wants to lock in oil at $40 a barrel? The answer: any E&P executive who wakes up every morning wondering how they will make their interest payments.

This chart shows open interest by speculators and oil companies alike in each monthly contract:

Leading Hedge
Open interest in light, sweet crude oil futures by contract
Source: Bloomberg

Most of the action, as usual, is in the near-dated futures But several traders say the interesting contract here is the one for December 2017, because open interest looks unusually high this far out. The likelihood is that producers are taking advantage of the current rally to lock in hedges, adding an obstacle to the fundamental rebalancing of supply and demand that the market needs. Traders are right not to put a ring on this rally.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net