Historic Low In Producer Short Positioning In Crude Oil: A Signal Of A Potential Major Shift In The Global Oil Market

The latest Commitment of Traders report (COT) raises questions about the future of the energy complex. Producer short positioning has hit its lowest level since August 2015, an indication that weakness in the oil market may not be a short-term phenomenon, but rather it could usher in a new dynamic within the global economy. Producer positioning is a key data point to focus on; it provides insights into how energy companies are hedging their physical inventory and future production plans. A high level of short positions for producers provides a foundation for price stabilization. Typically, as prices reach a certain level, energy companies like Exxon Mobil XOM and Occidental Petroleum OXY will short futures contracts to synthetically lock in prices, a practice also referred to as hedging spot price risk. However, a low level of short positioning indicates that either production levels may be increasing, or inventory levels may rise while demand is slowing. Remember, producers use these products to hedge, not to speculate. As demand for physical supply rises, the need for hedging is necessary to reduce the risk of prices falling. There may be several reasons for this dramatic drop in positioning, but unfortunately, we are too early in the data to make a firm determination.

Industry data shows that global inventory levels continue to increase. Production from non-OPEC countries like the United States has shocked the industry. The renewed interest in the Permian Basin, along with offshore production, which has improved dramatically over the years as technology has made extraction more efficient, has made domestic production economical again. Positive data from the most recent Baker Hughes Rig Count report on November 24th indicates that rigs are coming online across the globe after a brief slowdown during the summer.

If current production levels continue, this puts OPEC+ in a difficult position. Their strategy to reduce supply impacts each country differently. As supply decreases, prices theoretically stabilize or can even go higher, based on basic supply and demand principles. However, this can impact the GDP of these producing countries as they also sell fewer quantities of oil, especially during an economic slowdown, which we are currently experiencing globally. We continue to see oil prices slide even with these production cuts, potentially signaling economic weakness that has been masked by cutting physical supply and artificially stabilizing prices.

Eventually, OPEC+ may view these healthy production levels from non-member countries as a threat, potentially leading to another battle like the one seen between 2013 and 2015. This could result in supply flooding the market to reduce the profitability of shale producers, as happened during that era, creating a bust in the Permian boom. This scenario is deflationary in the near term but could be a long-term headwind for energy companies diversifying their production portfolio.

Another scenario for the drop-off is that energy producers are witnessing a rapid slowdown in demand. Gas prices have dropped rapidly, indicating some softening in demand, but that is the result of increased supply. Light crude is more conducive for refining gasoline than heavier by-products like heating oil and diesel, which typically use sour, heavier crude and have been in high demand. Although we have witnessed some slowing in consumption in certain data points, this “rapid” drop off in demand has not materialized yet.

The final scenario suggests we may be near a short-term bottom for crude, and producers may start restructuring their positions moving forward. Unfortunately, it will take weeks to confirm this trend. Indicators to watch for include an increase in open interest, price direction, and volume trending around 1.2x to 1.5x the 5-day average. If this is the bottom, which is unlikely, it would also need to coincide with the thesis of consumer demand remaining strong and resilient over the next several quarters. If that is the case, then oil could be an inflationary headwind going into March and April of next year.

The future of the oil market appears to be at a crossroads, with possible outcomes ranging from continued price instability to a restructured global energy balance. As the industry navigates these uncertain waters, the importance of monitoring key indicators such as production levels, inventory data, and pricing trends becomes paramount. Whether the market is heading towards a new era of competition and diversification, or merely adjusting to short-term fluctuations, will depend on a multitude of factors, including technological advancements, policy decisions, and the overarching economic climate.

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