Hedge funds observe caution, wait for clear sign of oil rebalancing

Hedge funds have continued to cover their short positions in crude and refined products, but the impact on oil prices has been surprisingly muted so far, with a much smaller rally in prices than expected.

Hedge funds and other money managers reduced short positions in the five main futures and options contracts linked to petroleum prices by a combined 69 million barrels in the week to July 11.

Fund managers have cut the total number of short positions over two weeks by 116 million barrels, falling from a record 510 million barrels on June 27 to just 394 million barrels on July 11.

Over the same period, total long positions increased by just 10 million barrels, rising from 815 million barrels to 825 million barrels, according to regulatory and exchange data.

Short covering was widely expected after hedge funds established record or near-record short positions in most contracts by the end of June.

The concentration of short positions and relatively small number of long positions left the market looking stretched on the downside. Crowded trades such as this have often preceded a sharp price reversal in the past.

But instead of rallying, crude prices generally declined over the week between July 3 and July 11, and have only risen modestly since, indicating hedge funds found plenty of willing sellers as they closed their short positions.

If oil traders became less confident about further falls in prices, there was no sign of them positioning for a rebound.

Sentiment remains bearish despite the sustained draw in U.S. crude stocks, record U.S. refinery runs and repeated verbal interventions by OPEC sources.

Hedge funds built large bullish positions twice earlier this year, in February and April, anticipating a tightening oil market and higher prices, only to be disappointed and incur significant losses both times.

With investors’ patience wearing thin, few managers can afford to be wrong a third time, so many seem to be waiting on the sidelines until signs of market rebalancing are unambiguous.