Even higher oil prices? Traders take bets off

A sudden recent ‘pullback’ in oil prices has coincided with hedge funds freezing their bets on oil futures.

Rising oil prices are being felt by consumers at the bowsers. Picture: Tony Gough

Could the oil price have reached a post-Ukraine invasion peak? A solid drop in the price of crude has hit the market almost as quickly as the price jump witnessed a few weeks ago.

“We are definitely seeing a pullback,” says ANZ senior commodities analyst Daniel Hynes, who had put a target of $US135 a barrel for crude “in the current cycle”.

Oil prices briefly broke that target to hit $US139 recently. This week the price is closer to $US110.

Even without any resolution to the crisis in Ukraine, several key changes have occurred behind the scenes in the oil market that could be highly significant.

The most important is the sudden loss of nerve among oil hedge funds, which have dramatically cut the number of bets they are placing on the future price of crude.

Hedge funds that have been swarming into oil futures over the past few weeks suddenly put the brakes on activity in recent days: the so-called “open interest on oil futures” hit a seven-year low at the beginning of the week.

Similarly, oil trading is still signalling extreme conditions, but there has been a softening of the “oil vix”. The crude oil volatility index reached a peak reading of almost 80 early this month, but has since dropped closer to 70.

A string of Australia’s top oil stocks are also off the high levels they hit at the outbreak of the Russian invasion, even with a bounce in prices in Monday’s session. Oil producers Woodside and Santos are both lower, along with oil refiners such as Ampol and Viva.

The question nobody in the market can answer is whether the oil traders have suddenly stopped laying bets on the future oil price because they believe the best of the recent run is over, or instead they believe the market is literally too risky.

Traders say they are increasingly worried the sudden withdrawal of hedge funds will spring a liquidity trap that could set off major losses whatever way oil ­prices move next. Dealing in oil futures can be a treacherous activity. Two years ago oil futures managed to hit zero in a historic session.

“I would be very wary of calling a top here – nobody really knows where it will go next. The price can move very quickly in ­either direction,” Hynes says.

Certainly, the uneasy calm in oil markets has not translated to the bowser at petrol stations, where prices are testing $2.20 a litre. Indeed, Josh Frydenberg is still mulling whether to announce a temporary cut to fuel excises in the federal budget next week. Fuel excise is current set at 44c a litre.

Nevertheless, as Vivek Dhar, director of mining and energy commodes research at CBA, suggests, so-called demand destruction – the point at which con­sumers will no longer pay for a commodity and will instead seek to change their habits – will inevitably kick in to the oil market.

According to Dhar, “oil markets are also likely to see demand destruction at some point. It’s worth noting that oil prices, like gas, have retraced significantly lower than their recent peaks. That’s because financial markets are largely determining oil prices by assessing the likelihood of a diplomatic solution to the conflict in Ukraine.”

But most oil analysts believe that ultimately the only way oil prices will drop is a change to the global demand rather than any change in supply, which is much slower to organise.

Dhar says high oil and gas prices are already causing major shifts in behaviour across Europe: including the closure of paper mills in Italy and major reductions in industrial fertiliser production in Scandinavia. “It’s not surprising to see demand destruction first among European gas users. Physical shortages, linked to current sanctions on Russia, though, will eventually play a more dominant role in oil price determination,” he says.

In a dramatic intervention to try to cut global retail prices, the International Energy Agency has released a list of recommendations for Western governments that has all the hallmarks of a white paper from the 1970s.

The plan suggests the introduction of initiatives that would:

● Reduce speed limits on highways to ease petrol consumption.

● Support three-day working weeks.

● Introduce car-free Sunday programs in cities.

● Incentivise alternative transport.

● Reintroduce “car sharing” 1970s-style (as opposed to ride-sharing.

Though the outcome of the IEA proposal is as unsure as everything else in the oil market, industry analysts have forecast that it could largely offset the interrupted supplies from Russia if it was taken up. The plan could reduce oil demand in OECD nations by 2.7 million barrels a day within four months. This compares with the 3 million barrels a day reduction in Russian oil production expected by April.