Oil: The Long And The Short Of It

| About: The United (USO)

Summary

The Big Long is the thesis that Saudi/Gulf Producers supported oil prices by swapping use of Petrodollars/Petroeuros for 'Dark Inventory' of producer oil in storage or reservoir.

The Big Long position is now being unwound via massive Managed Fund futures positions with a prepaid Dark Inventory of crude oil creating a two tier 'false market'.

As a result of this false market June Brent Crude oil was squeezed creating a short sharp backwardation and a further squeeze is now in progress in July Brent.

While Saudi/GCC get their dollars back through futures markets, Glencore is awash with the first wave of prepaid Dark Inventory of oil released to the market.

Big Long - Reprise

My thesis of the Big Long is that Saudi/GCC producers used sovereign reserve assets (Petrodollars/Petroeuros) as capital to fund crude oil being stored off-market by commercial market participants.

This had the effect of inflating and supporting oil market prices, and was achieved - via investment bank "swap dealers" - through exchanging firstly (until mid-2014) US Treasuries and then (from early 2015) euro-denominated sovereign debt (probably Bunds) for a "Dark Inventory" of crude oil which was subject to Purchase and Resale (Prepay) agreements. In effect, this was a value swap of currency over time for oil.

The liquidity necessary for oil market cash flow came from Quantitative Easing (QE), which, until October 2014, came in dollars from the Federal Reserve Bank, and from January 2015 in euros from the European Central Bank.

Setting the Scene

My recent article set out how major Managed Money oil futures positions attributed to hedge funds, in fact, represent the unwinding of the Saudi/GCC Big Long position.

Market action is once again ramping up and as John Kemp of Reuters wrote last Friday 13th May BRENT looks ripe for another squeeze on the Jul contract repeating earlier squeeze on Jun contract

Futures Market Action

As Kemp's chart shows, the June/July Brent Futures contract spread blew out from a 40c contango to an 80c backwardation during the June 2016 spot month period. Did this have anything to do with physical oil demand for consumption? Not a bit of it, this was all about trader games in the Brent/BFOE physical crude oil market casino I was involved in overseeing over 20 years ago.

As I write, July Brent is up again by > $1.40/bbl while the contango continues to fall. It would be no surprise to see July Brent reach over $50/bbl before it expires accompanied by a short sharp backwardation in the July/August spread.

So what's going on? The first thing to report is that the massive long Money Market fund position which I wrote about here is now being liquidated as Kemp reports that HEDGE FUNDS have cut their net long position in crude futures and options by -88 million bbl (-13%) over last two weeks

Meanwhile in the Physical Market

There was breaking news about the Brent North Sea physical crude oil market on Friday 13th May as Zero Hedge - demonstrating that incomplete knowledge is a very dangerous thing with the Brent Complex - breathlessly asked: Holding 30% Of June Brent Crude Contracts, Is Glencore Manipulating Oil Prices?

Meanwhile, the sober industry oracle Platts neutrally reported the fact that Dated Brent differential surges to over three-month high

"....the June Forties program <is> almost exclusively in the hands of Glencore. Glencore's over 30 cargo position has seen them keep seven out of the first nine Forties cargoes and 14 out of the first 15 June BFOE cargoes in total"

At 600,000 barrels of crude oil per cargo that approaches $1bn of oil.

Through the Big Long Lens

In my analysis, Glencore have probably attempted to squeeze the market but have hit the iceberg of prepaid Dark Inventory lurking under the market surface.

My Big Long view is that many of the Money Market funds who have been massively long of the futures markets were neither active hedge funds nor passive ETFs but represented the on-exchange unwinding of the Saudi/GCC Big Long market strategy to lend dollars to oil producers in exchange for borrowing a Dark Inventory of prepaid oil.

So through the Big Long lens what we are seeing is Saudi/GCC getting their dollars or T Bills back via the futures markets, while at the physical end of the telescope an attempt by Glencore to squeeze the forward physical BFOE market by effectively cornering BFOE forward contract purchases may have come unstuck.(NB: BFOE squeezes are routine - the last one was in January)

How could that happen? The Big Long reason is that the Forties sellers - one could take an educated guess as to the identity - had already been paid for the oil. So the Saudis/GCC get their dollars/T-Bills back in exchange for returning the economic interest in the prepaid oil to the producer, who in turn then sells it to the unwitting Glencore.

The result is that Glencore appear to have been lumbered with crude oil they were not expecting and are now sitting on a big parcel of oil (although they might have been agile enough to pass the parcel to credulous Far Eastern buyers).

Meanwhile the next - July - wave of the Dark Inventory tsunami appears to be gathering rapidly while the regulators look the other way and market analysts dream up ever more outlandish explanations for price moves.

Beware of Geeks bearing Gifts

On the subject of analysts we see Oil prices jump as Goldman Sachs says oil market flips into deficit

I have always proceeded on the basis that the major function of geekish investment bank analysis is purely and simply to be an adjunct of their trading book. So banks advising investors to buy are all too likely to be positioned to sell to the muppets who take that advice. No doubt Goldman Sachs is the exception to the rule.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.