Ever since the February crash, when oil tumbled to 13 years lows, and when OPEC started releasing tactical headlines at key inflection points about an imminent oil production freeze (which not only never arrived but has since seen Saudi Arabia's output grow to record levels) which we first suggested were meant to trigger a short squeeze among headline scanning HFT algos, our suggestion was - as is often the case - dismissed as yet another conspiracy theory.
Six months later, this conspiracy theory is now a widely accepted fact, and as Bloomberg reports tonight, "well-timed" OPEC talk of a potential deal to freeze output, has "forced bears" into a historic squeeze and helped push oil close to $50 a barrel, prompting West Texas Intermediate from a bear to a bull market in less than three weeks.
"This is all courtesy of some very well-timed comments from the Saudi oil minister," said John Kilduff, partner at Again Capital LLC, a New York hedge fund focused on energy. "They’ve been successful over the last year in jawboning the market, and this is the latest example."
And while one can debate whether OPEC's "headline" leaks are timed to coincide with near-record short positions on WTI, one thing is certain: the past week saw the biggest crude oil short squeeze on record as money managers cut bets on falling prices by the most ever.
According to Bloomberg, Hedge funds trimmed their short position in WTI by 56,907 futures and options during the week ended Aug. 16, the most in data going back to 2006. And, as one would expect following yet another record short squeeze similar to the one experienced earlier in the year, WTI futures rose 8.9% to $46.58 a barrel in the report week and closed at $48.52 a barrel on Aug. 19. WTI is up more than 20 percent from its Aug. 2 low, meeting the common definition of a bull market.
Money managers’ short position in WTI dropped to 163,232 futures and options. Longs, or bets on rising prices, increased 0.1 percent, while net longs advanced 56 percent, the most since July 2010.
"This was a very short market so we were bound to get some covering," said Stephen Schork, president of the Schork Group Inc., a consulting company in Villanova, Pennsylvania. "
Schork added that we "probably won’t hear a lot from OPEC with prices up here, but if we get down to where we were a few weeks ago we can expect to hear more."
Ironically, even if OPEC does agree to a production freeze, it will be because its biggest members are already pumping at flat-out record levels, said Chakib Khelil, the group’s former president. Saudi Arabia, Iran, Iraq and non-member Russia are producing at, or close to, maximum capacity, Khelil said in a Bloomberg Television interview on Aug. 17. Saudi Arabia told OPEC that its production rose to an all-time high of 10.67 million barrels a day in July, according to a report from the group.
Saudi Energy Minister Khalid Al-Falih said that the talks may lead to action to stabilize the market. What he means is that while Saudi Arabia production levels will be "frozen" at an all time high, a level beyond which it could not produce even if it wanted to, all of its peers will be locked into a substandard output rate, which is also why few if any of them will agree to the proposal to be discussed next month in Algiers.
Meanwhile, as even OPEC tries to ignite HFT algo short squeezes (one wonders who OPEC's financial advisor inthis regard is), US shale is rapidly coming back on line: as reported on Friday, there has been an upsurge in drilling as prices have climbed. U.S. producers added oil rigs for an eighth week, the longest run since April 2014, according to Baker Hughes Inc. data on Aug. 19. Even the traditionally conservative EIA increased its domestic output forecast for 2017 to 8.31 million barrels a day from 8.2 million projected in July, according to its monthly Short-Term Energy Outlook released Aug. 10.
"In the U.S., DUC completion and the drilling of new wells are changing the production outlook," Morse said. "We might see U.S. production rise next year instead of falling."
For those who trade based on flashing red headlines, and not Econ 101, rising production means falling prices, absent a comparable increase in demand, which however with China close to filling its Strategic Petroleum Reserve, is about to enter freefall.
Finally, now that virtually all weak hands have covered, it is time for the "flip" trade, as oil resumes its slide, and shorts once again pile on, just as Morgan Stanley forecast when it said that the mega short squeeze would finally end last week. Tomorrow we will find out if MS was correct.