Surprising? It is not. Unexpected? Not really. Timely? Probably. Long-lasting? Implausible. The latest leg up started nearly two months ago. The oil complex bottomed out at the end of August. Since then, December Brent has gained 35% from high to low. December WTI has done even better with a jump of 36% but the CME product contracts have trumped crude oil with a rally of nearly 38%. In trending markets price corrections are inevitable and embedded in the modus operandi. In oil, it took place yesterday.

This retracement, however, ought to be just like previous ones – brief. After all, the break above the $80/bbl was the triggered by both supply and demand considerations and the underlying picture has not changed. Firstly, the OPEC+ alliance will only increase production by the pre-scheduled 400,000 bpd per month, much to the annoyance of oil consuming nations led by the United States. Secondly, the supply crunch in the natural gas, LNG, electricity, and coal markets inevitably impacts oil. Thirdly, this leads to increased demand for crude oil and oil products as winter knocks on the door of the northern hemisphere and Covid restrictions are being lifted.

Yesterday’s general weakness was once again the result of the US taking a different view from Europe on factors that influence oil prices. After a solid weekly performance all the five major oil contracts made fresh multi-year highs during London morning, but some length has been flushed out as New York woke up to the news of a 0.7% drop in September manufacturing output. The loss of confidence, as said above, is not expected to last, tight physical oil balance should prevail, and oil prices are to remain at elevated levels for the remainder of the year.

Money managers’ appetite grows for WTI

The weekly reports from the CFTC and ICE on the Commitments of Traders always provide a useful insight into the thinking of money managers. The latest data that covers the 7-day period ending October 12 still implies that the underlying sentiment is positive. This is despite a slight reduction in combined net speculative length (NSL) of WTI and Brent. Financial investors shed 17 million bbls of NSL week-on-week, chiefly due to a massive exodus out of the Brent contract. Yet, both WTI and Brent prices strengthened and the total NSL of the two main crude oil futures contracts are at 641 million bbls, well above the August dip to 526 million bbls. Because of the relentless march higher in price the amount invested in crude oil futures & options remains at around $53 billion, the highest since the middle of July.

The relatively unabated increase in NSL, however, hides distinctive characteristics. The rise in NSL in WTI has been predominantly the function of bulls adding to their exposures whilst net speculative length in the European benchmark has mainly been affected by shorts covering their positions, rather than bulls firing from all cylinders. Since the beginning of August, for example, an increase of 35 million bbls in WTI NSL was composed of a growth of 25 million bbls in gross length and a reduction of 10 million bbls in speculative short positions. During the same period Brent long positions have been cut by 20 million bbls and short positions by 10 million bbls leading to a reduction of 10 million bbls in NSL.

This change in fortune is probably best reflected in the latest set of data released Friday evening. Brent NSL fell sharply and 32 million bbls of paper oil migrated partly over to WTI where money managers added 15 million bbls to their existing positions. Producers who use Brent as a hedging tool have also reduced their net short positions by a whopping 30 million bbls. The growing popularity of WTI at the expense of Brent also means that the former now has 53% of the crude oil speculative market, the highest share since mid-July. Rising financial demand has led to stronger WTI spreads and to the narrowing of the arbitrage. The front-month contract, which was around 20 cents/bbl above the second month in August now commands a premium of 75 cents/bbl and the December/January price differential flirted with the $1/bbl mark yesterday. The WTI/Brent arbitrage, which was -$4/bbl at the end of August settled at -$1.89/bbl.

In a bull market it is usually Brent that leads the way higher but this time around domestic issues provide extra support for WTI. The recent hurricane season proved to be so disruptive that producers have not fully recovered from the damage caused by Ida. At the end of August domestic crude oil production dived to 10 mbpd and although it has almost reached the pre-hurricane level of 11.5 mbpd, output in the Gulf of Mexico is hindered by logistical issues. This is the main reason why the EIA has cut its 4Q 2021 domestic production forecast from 11.30 mbpd in August to 11.13 this month. Crude oil imports have not really made up for the lost production, at least according to the weekly data from the EIA. The latest four-week average figures, both net and gross imports, are around the pre-hurricane level therefore the relative strength of WTI over Brent and its solid backwardated curve will not come as a surprise.

Depleted crude oil inventories at Cushing, Oklahoma, are adding another layer of support to the US benchmark. Last week stocks at the NYMEX delivery point thinned nearly 2 million bbls. At 33.5 million bbls they are the lowest since October 2018. The deficit to the comparable period of 2020 stands at 26 million bbls and the 5-year average is nearly 12 million bbls higher than the current level. The ongoing energy crunch provides a solid backdrop to the current rally (despite yesterday’s pullback) and struggling production coupled with historically low Cushing stocks make WTI the darling of investors. And they will have no reason to desert the US crude marker as long as they are able to take advantage of the extra profit the backwardated WTI structure offers in the form of monthly rolls.