background image background image background image

What drove the three-day rout in crude oil

Picture of Ole Hansen
Ole Hansen

Head of Commodity Strategy

Summary:  The three-day 11% rout in Brent crude oil highlights the risk when speculative positions become too one-sided. Despite a rangebound market since November, the combination of backwardation and lower volatility helped drive a tripling of the net long held by hedge funds during this time. A long that is now seeing a forced reduction in response to a deteriorating technical and fundamental outlook


Today's Saxo Market Call podcast
Global Market Quick Take: Europe


Since our latest crude oil update where we highlighted the downside risks driven by the collapsing risk appetite, we have seen some considerable downside moves across growth and demand depending on commodities, from crude to copper and cotton. As the banking crisis which started last week in the US spread to Europe and Credit Suisse on Wednesday, the need to reduce across market exposure accelerated.

In terms of oil demand, we are currently seeing a widening gab Western nations and Asia, especially China which continues to recover from its extended lockdown period. In their latest oil market report OPEC lower its demand for forecast for OECD countries while raising its demand for non-OECD countries, including China and India. Overall, the group stuck with its call for global demand to rise by 2.3 million barrels a day this year to 101.9 million barrels a day. A projection that is being based on global growth of 2.6% this year, with China’s economy growing by 5.2% while the Eurozone and the US economies will be bumping along at much slower pace of 0.8% and 1.2% respectively.

The IEA followed up on Wednesday by saying that global oil stockpiles have risen to the highest in 18 months with Russia managing to maintain production of its sought after heavily discounted oil by refineries, especially in India and China. However, “It remains to be seen if there will be sufficient appetite for Russian oil products now that the price cap is in place or if its production will start to fall under the weight of sanctions,” the agency cautioned. The agency held onto expectations that global oil demand will increase by 2 million barrels a day this year, thereby surpassing pre-pandemic levels.

16olh_oil1

The three-day 11% rout in Brent crude oil highlights the risk when speculative positions become too one-sided. Despite a rangebound market since November, the combination of backwardation and lower volatility helped drive a tripling of the net long held by hedge funds during this time. In the week of March 7, the gross long reached a 16-mth high at 320k contracts while the gross short was cut to 22k contracts, a 12-year low. As the long/short ratio reached a four-year high at 14.5 there was a very limited short position left to absorb the sudden burst of long liquidation once the floodgates opened on Monday when the trendline support at $81.70.

16olh_oil2

The prompt month backwardation (indicating a tight market condition) at 44 cents has only suffered a small reduction from around 60 cents last week, indicating no significant change in underlying fundamentals. And unless the recession story gains further traction, we conclude this move was mostly driven by position squaring and that fresh buying will likely emerge once stability returns.

16olh_oil3
Source: Bloomberg

From a technical perspective, according to Kim Cramer, our technical analyst’s latest update there is no doubt that the breakdown has change the short-term technical outlook, potentially driving fresh short selling and continued long-liquidation from funds who normally enter and exit positions over several days. However, based on previous experiences, holding a short position when the market is in backwardation is often difficult and the full downside potential may not be met.  

16olh_oil4
Source: Saxo

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.