Bullish crude oil futures and options rise to around two-year highs

London

BULLISH crude oil speculative positions have climbed to around two-year highs as US and North Sea production has begun to rise.

Compilation of the US Commodity Futures Trading Commission futures and options statistics show that net "long", that is, bullish futures and options, crude oil positions have surged to around 440,000 contracts compared with around 160,000 when prices were depressed a year ago. Since each contract comprises 1,000 barrels, the position of hedge funds and other speculators is around 440 million barrels, equivalent to almost five days' demand.

Speculative enthusiasm for oil took off in recent weeks when members of the Organization of the Petroleum Exporting Countries (Opec), led by Saudi Arabia, agreed on production cuts. As a result, Brent oil, which bottomed around US$30 a barrel at the beginning of last year, has appreciated to a more comfortable level of US$55.86 a barrel, while the trend has been similar for West Texas Intermediate (WTI), which is trading at a US$3 discount to Brent.

Commodity analysts such as Eugen Weinberg of Commerzbank contend that the oil market is overbought on the grounds that shale oil fracking is increasing in North America again. According to oil services company Baker Hughes, US and Canadian oil rigs rose by 90 in December last year to 843 rigs, not far below the 874 level in December 2015. Norway's oil and gas output will be higher in 2017 and 2018 than previously expected, the Norwegian Petroleum Directorate (NPD) predicted.

Moreover, with nations such as Libya beginning to raise production, contrary to Opec's accord, Mr Weinberg believes that history could repeat itself and that more Opec output could leak to the market, despite the agreement to slash production.

Oil bulls, however, contend that general Middle Eastern instability, rising demand in China and a stronger US and global economy will underpin oil prices which are still way below the US$110 level in late 2014.

Russia, the largest non-Opec producer, has also cut production, they say. Iraq, Kuwait and Saudi Arabia, however, have insisted they will stick to the Opec accord.

Moreover, the state-owned China National Petroleum Corp (CNPC) predicted this week that China's net crude imports will rise 5.3 per cent to 396 million tonnes or around eight million barrels a day in 2017, to supplement the nation's own production. Thus, China's total crude demand will hit a record 594 million tonnes this year or almost 12 million barrels a day.

Not surprising, oil price predictions of traders and analysts are all over the place. A Reuters poll of 29 analysts and economists carried out after the Opec deal shows that the highest level was US$83 per barrel and the lowest was US$40, while the average prediction was US$57. Much will depend on the fundamental oil demand and supply projections.

"Before the agreement among producers, our demand and supply numbers suggested that the market would rebalance by the end of 2017," the International Energy Agency (IEA) states. "But Opec, Russia and other producers are looking to speed up the process.

"If Opec promptly and fully sticks to its production target, assessed at 32.7 million barrels a day, and non-Opec producers deliver their agreed cuts, then the market is likely to move into deficit in the first half of 2017 by an estimated 600,000 million barrels a day."

IEA estimates thus show that global demand will average around 96.9 million barrels a day in the first half of this year and global production at 96.3 million, illustrating that Opec is the swing producer that is changing the balance of the market.

The question is whether Opec's agreement is already baked into a price which has jumped by 85 per cent from its early 2016 lows. Besides fracking and other output rises, and uncertainty about demand, inventory levels need to be taken into account. The IEA estimates that total above ground industry and government strategic inventories of oil at the end of September 2016 reached 4,650 barrels or 202 days, compared with 4,533 or 193 days a year previously. This, excludes the sizeable speculative position that has been built up.