Earlier today we showed how, courtesy of massive synthetic positions where Oil ETFs are currently net long 272k lots of oil, equal to 56% of the front month open-interest in futures, the price of oil is being propped up by ETF buying, either outright or via an ongoing, relentless short squeeze.
This was to be expected: as we warned a little over a month ago, as a result of a record number of oil shorts, there is a "constant threat of a short squeeze." As SocGen further elaborated, "a positive surprise could happen quite sharply, as short positions are likely to be squeezed by a profit-taking move. On WTI, the in-the-money short positions are really dominating at the front end of the curve while out-of-the-money long positions are dominating at the long end of the curve: the front end of oil curve could thus be more exposed to some profit-taking."
It certainly has.
Today, one Wall Street firm confirms that indeed the recent move in oil has nothing to do with fundamentals, and everything to do with positioning, and as UBS explains, "the performance is TOTALLY short-squeeze led."
RECENT ACTION/ SENTIMENT:
Yesterday oil ended in the green despite a very large reported crude inventory build, a reflection of how biased to the downside sentiment and positioning already is. Today, crude started in the read and has been mixed from there but moving higher. And both days, the stocks have lead with energy the best performing subsector in the S&P.
Now, there is no doubt that the performance today is TOTALLY short-squeeze led. Though it also shows how negative sentiment and positioning is.
Interestingly, with energy outperforming the market the last few days for the first time in a very long while, I actually got a few long only generalist type calls yesterday. Nothing concrete but generalists who are underweight the space trying to figure out if this is a turning point…
WHAT HAS HELPED FUEL THIS SHORT SQUEEZE?
- Positioning and sentiment very biased to the short side/ underweight. And as we move up, the move is also exxacerbated by short gamma positions that have to cover at higher levels.
- Despite high oil inventories (and still building), most upstream producers (from Exxon on down) have guided to lower than expected production as a result of lower capex.
- Ongoing hopes of a potential agreement between OPEC and non-OPEC members (seems umlikely but now a meeting set for March 20th is reviving some market hopes).
- A couple of supply issues like Kirkuk/Ceyhan pipeline damage taking longer to repair than expected and Farcados force majeure in Nigeria still on going issue.
- Credit players covering equity shorts --- evident today that "good credit names" are underperforming and "bad credit names" outperforming.
- We took a day break from equity issuances in the space ystd and this morning… despite energy's strong performance. Though rest assured we haven’t seen the end of issuances yet (RRC WLL, RSPP, MUR, CRZO GPORare all top of mind)… by the same token all this energy issuances are helping the credit side of things which has also been the culprit of the issue.
One may wonder if the squeeze is forced, or simply momentum driven, although we would like to quickly point us that most of the recent equity offerings by O & G companies who have benefited from the rally have noted in the "use of proceeds" that the raised capital would be used to pay down secured debt, i.e., take out the banks. In other words, it is as if the banks are orchestrating a squeeze to allow the shale companies to raise capital which will then allow them to repay their secured debt to the banks, secured debt whose recoveries as we have recently shown are practically non-existent in bankruptcy.
Which in turn means that all that is happening is a new layer of equity is coming in to take out the same banks who, as we recented noted, no longer have an interest in being in part of the capital structure. Impossible, you say? Recall what MatlinPatterson's Michael Lipsky said two weeks ago:
"we always assume that secured lenders would roll into the bankruptcy become the DIP lenders, emerge from bankruptcy as the new secured debt of the company. But they don't want to be there, so you are buying the debt behind them and you could find yourself in a situation where you could lose 100% of your money."
Which leads us to the most important question: if the oil recovery is "real" why are the banks in such a desperate scramble to get the hell out of Dodge?
As for what this means for returns to new equity investors, we believe the answer is self-evident.