Over the weekend, we published a report detailing how short sellers are piling back into the oil markets. Today, we are getting a glimpse of what's to come when extreme positioning happens.
WTI moved up over 2% on the back of rumors that OPEC is contemplating the production freeze deal again. As we said in the short selling report:
Despite a massive increase in short interests, oil prices this time around didn't fall nearly as much. Hedge funds that were long oil contracts saw the opportunity to add additional exposure, which tempered the recent fall.
We think it's important at this juncture to balance the short-term view with the long-term view. Yes, we might be facing a surplus in gasoline storage and, yes, refinery crack spreads just hit a multiyear low. But the important thing to remember here is that multiyear capex projects are based on current oil prices. If the market takes an overly bearish view on oil prices in the near term, it would only serve as a massive rubber band effect for oil prices in the long run. Perhaps the adage "low commodity prices cure low commodity prices" is true after all, and the longer oil prices remain depressed, the more dramatic the bounce.
Now, going back to what made the price pop higher: Reports of OPEC potentially instating a production freeze deal created headline risks for the short sellers. Will OPEC actually implement the freeze deal? We think the probability of a production freeze deal is close to 0%. As we wrote in detail in this report, there are many issues with a production freeze deal. Russia and Saudi tensions are worsening, and the Syria proxy war between the two have not yet been resolved.
Iran's oil production remains below pre-sanction levels of 4-4.2 million b/d, so it won't be until next year before it hits pre-sanction production levels. Iran has already indicated it's not interested in any production freeze deal. These two caveats alone make the production freeze deal impossible, and that's not to say if other OPEC countries would try and cheat their way out of it.
The recent fall in oil prices had something to do with fundamentals, but mostly it was the cause of extreme positioning. If there's one thing you should know by now, it's that markets tend to overreact in the short run. So is this rally on the back of fundamental changes? No, but neither was the fall. Let us know in the comment section below how long you think this short squeeze could last.
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