Hedge funds have undone all their wagers on an OPEC-driven oil rally, and that could be good for prices.

Bets on West Texas Intermediate futures have all gone back to where they were before OPEC agreed to cut output, data from the U.S. Commodity Futures Trading Commission show. The silver lining is that this is how money managers lay the groundwork for a rebound, and the steady drop in U.S. supplies may be just the fodder optimists needed to start anew.

"There’s now fresh ammunition ready to reenter the market," John Kilduff, a partner at Again Capital New York-based hedge fund that focuses on energy, said by telephone. "A huge shake out invites a rally."

That turnaround might already have started. Crude had its best week since March after stubbornly high U.S. stockpiles fell the most this year, giving hope to investors searching for signs that a global glut is easing. It was the fifth straight decline, and it was accompanied by drops in gasoline and distillate fuel inventories.

"We should continue to have crude draws, the last one was profound," Jay Hatfield, a New York-based portfolio manager of the InfraCap MLP exchange-traded fund with $375 million in assets, said by telephone. "There will be a lot of attention paid to U.S. stockpiles in the weeks ahead."

WTI rose 3.5 percent last week to settle at $47.84 a barrel on Friday, still a long way from this year’s intraday high of $55.24. The rebound followed a rout that wiped all the gains from the past five months amid growing signs that production cuts by the Organization of Petroleum Exporting Countries and its allies failed to rebalance the market.

Skeptics will be keeping an eye on rising U.S. output, which reached 9.3 million barrels a day in the week ended May 5, the highest since April 2015, according to the Energy Information Administration. Output is poised to rise further in the months ahead as U.S. explorers stage the longest drilling ramp-up since 2011.

Shorts Surge

Money managers’ WTI net-long position tumbled 17 percent to 168,814 futures and options in the week ended May 9, according to the CFTC. That was the lowest since November. Longs, which had already slumped to pre-OPEC deal levels a week earlier, edged up 2.1 percent. Shorts surged 37 percent and have tripled since the end of February.

While the surge in bets on declining prices reflects a loss of faith in OPEC’s ability to rebalance the market, it also paves the way for a rebound when positive news like the U.S. stockpiles slump rekindles optimism. That’s because at some point short-sellers need to go on a buying spree called short-covering to return securities they borrowed and sold. The coming weeks will tell if that’s what’s happening.

"One thing to keep in mind while you look at these numbers is that more selling now, means more potential buying later," Tim Evans, an analyst at Citi Futures Perspective in New York, said by telephone. "There’s potential for some short covering."

Source:
courtesy of BLOOMBERG

by Mark Shenk

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