OPEC has mounted yet another charm offensive as a result of last week’s roughly 5% crash in the global price of crude. As was widely reported by the wire services, the headline from Saudi Oil Minister Khalid al-Falih to the effect that the Saudis would do whatever it takes to end the global supply glut of crude hit the world press on 8 May and gave markets a short-term boost. Al-Falih was quoted as saying that global oil markets had improved from 2016 lows when crude prices fell below the $30 per barrel level for a reason. “I believe the worst is now behind us with multiple leading indicators showing that supply-demand balances are in deficit and the market is moving towards rebalancing. We should expect healthier markets going forward.” He also expected global oil demand to grow roughly equivalent to last year with both China and India remaining moderate to strong consumers of Saudi black gold. What’s more, al-Falih stated very firmly that the six-month extension is all but a done deal and even suggested that OPEC is looking at extending the cuts beyond the end of 2017.
Well, he would, wouldn’t he? But is the market believing it? As can be gleaned from the weekly COT (Commitments of Traders) reports from the CFTC (U.S. Commodity Futures Trading Commission), the big bullish bet on crude for this cycle really began in November 2016 amid noise out of OPEC regarding the cuts, but before any concrete action actually occurred. As at mid-November 2016, the bulls outweighed the bears by about 276,000 WTI contracts, with the peak recorded on February 21 2017 at just over 566,000 contracts. That was an easy double in just about three months. The latest trading data, however, shows that hedge funds and other speculators have decreased their bullish bets, taking their net longs down to about 373,000 contracts, the lowest level since the OPEC deal was announced last year. That’s a 34% drop from peak to current trough. Put another way, OPEC credibility has taken a hit of about one-third.
The media must assign reasons for daily movements in the price of crude: the OPEC deal is on/is off; OPEC will extend into 2017, no it’s going to be 2018; global economic growth will be higher than anticipated this year resulting in more crude being consumed/no it won’t; demand for crude is rising faster than previously forecast especially in emerging markets/no it isn’t, etc. In reality, price movements are largely random and largely in the realm of higher mathematics as speculative funds’ algorithms are very similarly structured and tend to respond in concert as the crash last week attests.
So if OPEC is huffing and puffing and the funds aren’t buying it, what other measure can prove or disprove what appears to be mounting pressure for a longer-term downward leg in WTI? Interestingly, during the big build-up in hyper-bullishness from November 2016 to February 2017, the volatility of crude as measured by the CBOE oil VIX index (OVX) decreased markedly (see chart). The VIX is sometimes called a fear barometer and sometimes a complacency indicator, since it derives its value from the volatility input in crude oil futures/options pricing. Like its U.S. stock market VIX equivalent, which tracks the S&P 500 and has shown similar historic lows, the big question is why, and the answer is that trending markets both on the upside and the downside reflect higher conviction and lower volatility. Note, however, during this cycle the big down move in the OVX from the mid-50s in November 2016 to the mid-20s in February, a decline of almost 55%. Also note that the OVX has now turned higher, rising fairly sharply into the mid-30s as the correction began in earnest last week.
Higher OVX, of course, means higher volatility and as a result the higher the probability of bigger price moves. Combine that with lower futures open interest and it’s clear that OPEC’s pronouncements are going to be falling on fewer and fewer receptive ears.
The United States Oil Fund LP ETF (NYSE:USO) fell $0.01 (-0.1%) in premarket trading Friday. Year-to-date, USO has declined -15.19%, versus a 7.09% rise in the benchmark S&P 500 index during the same period.
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