August crude futures prices fell 6% in the week ending July 26 th (to correspond to the data below), closing at $42.92. Prices softened later in the week, closing down another 3% at $41.49.
Over the past several months, I have been highlighted the fact that there is a relatively high negative correlation (-60%) in weekly price changes to weekly changes in short speculators' positions.
I have explained that the "freeze" concept had altered the risk-return of short speculators, who were responsible for driving prices lower. From mid-February through the end of May, 138 million barrels in speculative short positions were covered (bought), propelling prices higher.
Since early June, the "headline risk" premium has begun to deflate. Consequently, as noted specifically below, short speculators began increasing their short positions, causing prices to drop. From late May through July 26th, short speculators have added over 125 million barrels to their short positions, depressing prices.
Commitments of Traders
Utilizing the Commodity Futures Trading Commission's (CFTC) Commitments of Traders (COT) reports for crude oil, I was able to dissect how traders were re-positioning last week.
The four groups I follow - Hedgers (Producer/Merchant/Processor/User) Longs and Shorts, and Speculators (Money Managers) Longs and Shorts - are defined below:
Hedgers: A "producer/merchant/processor/user" is an entity that predominantly engages in the production, processing, packing or handling of a physical commodity and uses the futures markets to manage or hedge risks associated with those activities.
Speculators: A "money manager," for the purpose of this report, is a registered commodity trading advisor (CTA), a registered commodity pool operator (CPO) or an unregistered fund identified by CFTC. These traders are engaged in managing and conducting organized futures trading on behalf of clients.
The latest data are for the week ending July 26th and include data for both options and futures combined for the New York Mercantile Exchange (NYMEX). All comments below pertain to each group as a whole, on balance, noting there are exceptions among individuals.
Short speculators increased positions (sold) 38,897 contracts, increasing their total to 180,134 contracts. Over the past two weeks, they sold over 65 million barrels. This brings their positions back to almost where they were before the "freeze" talk first started in mid-February.
But although short positions have nearly returned to their mid-February level, but oil prices have not. Given that their short positions are close to their historic highs could mean that the selling pressure is near a climax and they will not force prices much lower.
Long hedgers did just the opposite, buying 13,235 contracts last week, increasing their total to 256,386 lots. This group would include refiners who hedge crude purchases for processing, as well as large end-users, such as airlines. From a long-term perspective, their overall length is on the low end, implying less confidence that the upside potential justifies the downside risk.
Short hedgers, primarily crude producers, increased the size of their positions (sold) by 12,548 lots to 508,911 contracts. This was in contrast to their large buy in the prior week. Overall, short hedges remain lower than where they were before when prices were higher.
Finally, spec longs bought 2,649 contracts last week, ending with 300,690 lots. It is interesting that both longs and short speculators increased their bets, as well as both long and short hedgers. In a long term perspective, this group is closer to the upper end of their historical length, implying they may not be as willing to add much more buying power to the market.
This begs the question of what is going on overall. I netted the long and short positions of both these hedgers and speculators since mid-June 2006, and the graph below shows the size of the net long positions peaking in July 2013.
More specifically, net positions are close to their lows. This may be a signal that prices are getting close to their bottom.
With all of the selling since early June, prices have dropped about $10 per barrel. While this is a considerable drop, the above data imply the market may be approaching the end of its selling pressure.
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.