Oil Market Outlook: Traders Bearish as OPEC+ Options Seem Exhausted

Investor Pessimism Over Petroleum Prices

Investor sentiment towards petroleum prices has never been more negative, according to energy analyst John Kemp. This pessimism is fueled by indications that major industrial economies are slowing down. Investors also believe that Saudi Arabia and its OPEC+ allies have exhausted their options and are either unable or unwilling to further restrict their production to counterbalance the decrease in consumption growth and the drop in prices. In the week ending September 10, hedge funds and other money managers sold the equivalent of 128 million barrels in the six most significant futures and options contracts. Over the past ten weeks, fund managers have sold petroleum in eight of them, reducing their combined position by a total of 558 million barrels since July. For the first time on record, funds held a net short position of 34 million barrels, a significant drop from a net long position of 524 million barrels on July 2.

Record Sales Across the Board

The most recent week saw substantial sales across all sectors, led by Brent (-54 million barrels), but also including NYMEX and ICE WTI (-27 million), European gas oil (-20 million), U.S. diesel (-15 million), and U.S. gasoline (-11 million). Fund managers have sold Brent in seven of the past nine weeks, reducing their position by a total of 213 million barrels since July 9. For the first time on record, funds held a net short position in Brent of 13 million barrels, down from a net long position of 200 million barrels nine weeks earlier. Fund managers also held a record net short position of 48 million barrels in European gas oil and a near-record net short position of 39 million barrels in U.S. diesel. Even in WTI and gasoline, where sentiment was not as negative, positions were only a few million barrels above record lows. In the premier NYMEX WTI contract, fund managers have increased short positions by a total of 61 million barrels in the last four weeks.

Conditions for Potential Price Jump

The accumulation of bearish petroleum positions has created a crowded market, setting conditions for a potential sharp price increase if the news becomes less negative. However, investors are currently focused on the limited options available to OPEC+ to counter the deteriorating economic outlook.

Investor Despair Despite Lower Prices

Despite Brent futures prices falling to their lowest in real terms since early 2021, investor pessimism remains high. After adjusting for inflation, crude prices have fallen to levels last seen during the height of the coronavirus pandemic when the first successful vaccines were just being announced. Inflation-adjusted Brent prices have averaged $72 per barrel so far in September, putting them in the 35th percentile for all months since the turn of the century, down from a recent high of $90 (57th percentile) in April.

Need for Production Deceleration

The price slide is signaling a strong need for a further slowdown in production growth to match the worsening macroeconomic environment and consumption outlook. Since October 2022, Saudi Arabia and its OPEC+ partners have announced production cuts totaling 5.66 million barrels per day (b/d) to reduce excess inventories and drive prices higher. Recently, the group has been trying to unwind some of those cuts but has been forced to postpone planned output increases due to the slowdown in consumption and renewed slump in prices. Investors believe the group is not willing to cut production further in the short or medium term. The burden of adjustment must therefore fall on rival producers in the United States, Brazil, Canada, and Guyana, which have accounted for nearly all output growth in recent years.

U.S. Natural Gas Outlook

Investors are cautiously building a bullish position in U.S. natural gas as ultra-low prices and record consumption by gas-fired generators reduce excess inventories inherited from the exceptionally mild winter of 2023/24. Hedge funds purchased the equivalent of 192 billion cubic feet (bcf) in the two major futures and options contracts tied to prices at Henry Hub in Louisiana over the seven days ending on September 10. Funds have purchased a total of 290 bcf over the last two weeks, taking their net long position to 507 bcf (45th percentile for all weeks since 2010), though the position is still far below the recent high of 1,170 bcf (60th percentile) in mid-June.

Inventory Normalization and Winter Outlook

Inventories have been normalizing rapidly as ultra-low prices have encouraged maximum consumption by power generators in the last stages of the summer air conditioning season. Working inventories increased by a total of just 188 bcf over the nine weeks ending on September 6, the smallest seasonal accumulation for more than a decade, and less than half the average of 441 bcf in the past ten years. As a result, in early September stocks were still high but back within the normal range of ± 1 standard deviations away from the average for the first time since early February. With the main air conditioning season almost over, inventories will soon start rising faster, and are likely still to be above average when the main winter heating season starts on November 1.

Bottom Line

The oil market is currently in a state of despair, with traders bearish and OPEC+ seemingly out of options. The burden of adjustment appears to be shifting to rival producers, particularly in the United States. Meanwhile, the U.S. natural gas market is seeing a cautious bullishness due to ultra-low prices and record consumption. As we approach the winter season, inventories are expected to rise, but at a slower pace than usual. These developments present a complex picture of the energy market. What are your thoughts on this situation? Feel free to share this article with your friends and discuss it. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.