Oil speculators have no idea where the price is going

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The signals from major investors, oil companies, and OPEC have clouded the picture for where oil prices will go next. Oil prices have crashed from the heights of $100+ per barrel just 18 months ago, down to the lows of $30 per barrel. But what happens next?

There is no shortage of clues, but they all add up to a fuzzy outlooks, leaving a very confused assessment of the state of play in the oil markets.

On the bullish side of things, the current oil price level is untenable, something that has been true for some time. An estimated 3.4 million barrels per day (mb/d) of oil production is currently “cash negative,” a situation that cannot carry on indefinitely. With the glut in oil production estimated to be only somewhere around 1 mb/d, today’s prices are clearly not sustainable.

Moreover, the entire industry is taking a heavier axe to spending and upstream investment. Out of 18 large oil and gas companies that have reported earnings, spending was slashed by 40 percent on average, according to a Reuters survey. The top 30 U.S.-based oil and gas companies slashed their 2016 spending plans by 70 percent over the past year.

Oil production has remained steady over the past six months in the U.S. shale patch, but the severe cuts in spending and the sharp fall in rigs – down by another 48 last week – will lead to lower output. "The capital cuts that the industry is making should result in ... a supply shock to the downside," Ryan Lance, CEO of ConocoPhillips, said last week. The EIA sees production falling to 8.5 mb/d by 2017, a little more than 1 mb/d below the April 2015 peak of 9.6 mb/d.

On the other hand, there are plenty of reasons to believe no meaningful rally will occur in the short run. For one, oil storage levels continue to climb, with another sharp rise exhibited since mid-January. U.S. crude inventories jumped by 20 million barrels between January 8 and early February. Storage levels now exceed 500 million barrels, the highest level in 80 years. A substantial increase in prices won’t occur until these storage levels start drawing down in earnest, a trend that has yet to arrive.

Perhaps more importantly is the state of the global economy. Concerns over a worldwide recession have clouded much more than the oil markets. The Dow Jones Industrial Average is down to 15,847 as of February 8, the lowest level since early 2014. In a sign that investors are losing confidence in global growth, hedge funds are beginning to bet against the performance of corporate bonds, which amounts to a wager against the global economy.

What does all of this add up to? Nobody knows. When oil was $45 per barrel in late 2015, the markets saw plenty of room for oil to fall, and bets on sub-$30 oil proliferated. But now there is much less room on the downside, so the oil markets are in a weird state of limbo.

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The cloudy picture means that oil speculators are no longer in agreement. The general consensus a few months ago was that oil had a lot more room to fall, and as hedge funds and money managers piled into short positions, they helped push oil down below $30 per barrel. The short positions reached multi-year highs at the end of 2015.

More recently, however, bets on rising prices are increasing and short positions are starting to be closed out. Reuters reported last week that there was a sudden flight of $600 million worth of shares in an ETF that shorts oil, a move that suggests large investors think oil is hitting bottom.

But it has yet to turn into a stampede, given the underlying fundamentals. Speculators are at odds over what happens next. Even as there is increasing disagreement over the direction of crude oil prices, there are more and more people with an opinion on it: bets on oil – up and down combined – hit their highest levels since 2006. Both long and short positions climbed in early February to 497,280 contracts. All of the volatility, plus the historic nature of the crude price crash, is attracting a record level of wagers.

“This is a reflection of a lot of conviction on both sides,” John Kilduff, a partner at Again Capital LLC, told Bloomberg in an interview. “We’re seeing a battle royal between those who think a bottom has been put in and those who think we have lower to go.”

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