Just Two Headlines: For Oil 2016 Is Setting Up To Be A Rerun Of Last Year

One week ago when Morgan Stanley was lamenting the relentless buying by algos (or as he called them "macros" and saying "forgive the macros – they know not what they do") who have taken over the function of setting the price of oil despite "increasingly bearish fundamentals", the bank's analyst Adam Longson asked one question: will the summer of 2016 be a rerun of last summer when oil jumped from $45 to $60 only to tumble into the end of the year.

We don't know the answer, although at least for now it certainly appears that much of the euphoria that had gripped the oil market last year has returned with a vengeance, even if for the time being $45 appears to be the new $60.

However, what we do know is that what may have been the primary catalyst behind last year's eventual drop in oil prices is back: hedging.

This is what Reuters writes in an article from earlier today:

The highlights:

U.S. oil producers pounced on this month's 20 percent rally in crude futures to the highest level since November, locking in better prices for their oil by selling future output and securing an additional lifeline for the years-long downturn. The flurry of dealing kicked off when prices pierced $45 per barrel earlier in April. It picked up in recent weeks, allowing producers to continue to pump crude even if prices crash anew.

 

While it was not clear if oil prices will remain at current levels, it may also be a sign producers are preparing to add rigs and ramp up output.

 

"U.S. producers have been quick to lock in price protection as the market rallies given that the vast number of companies remain significantly under hedged relative to historically normal levels," said Michael Tran, director of energy strategy at RBC Capital Markets in New York.

And now compare the above article with the following Reuters story from exactly one year ago, when WTI had just hit $60 and would stay there for the next two months.

U.S. oil producers are rushing to take advantage of the rebound in oil markets by locking in prices for next year and beyond, safeguarding future supplies and possibly paving the way for a rebound in production. The flurry of hedging activity in the past month will help sustain producers' revenues even if oil markets tumble again, which is bad news for OPEC nations, such as Saudi Arabia, that are counting on low prices to stunt the rapid rise of U.S. shale and other competitors.

 

Oil drillers are racing to buy protection for 2016 and 2017 in the form of three-way collars and other options, according to four market sources familiar with the money flows. In some cases, that means guaranteeing a price of no less than $45 a barrel while capping potential revenues at $70.

 

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With rising prices, producers are locking in the upside, concerned that the rally may fizzle out with U.S. oil stockpiles at record highs - and as some producers, such as Pioneer Natural Resources start thinking about drilling again.

Last year, producers were very right to hedge prices because WTI proceeded to lose 30% of its value just over 6 months later. It is safe to say that this time they will again be right to hedge; the only question is when will the 2016 rerun of last year's oil price leg lower begin. If last year was indeed a "deja vu" indication, we expect late June is when the next leg lower for oil begins in earnest, unless these same "macros" decide to frontrun the selling well in advance.