Oil Gets Risky for Traders

• Oil traders are increasingly bearish, selling futures despite supply concerns and potential disruptions in the Middle East.
• Economic data from the US and China, along with demand worries, are driving the pessimistic sentiment in the oil market.
• Algorithmic trading is contributing to oil price volatility, with traders reacting strongly to news and trends.
• A potential supply shock, such as a significant escalation in the Middle East conflict, could be the catalyst needed to change the bearish market sentiment.

A wider war in the Middle East may be looming over oil markets and OPEC is still keeping curbs on supply—but traders are selling. Despite recent gains, the market for crude remains overwhelmingly pessimistic. It would take a supply shock to change this.

When earlier this month, Iran swore to avenge the killing of Hamas Leader Ismail Haniya by Israel, oil prices jumped in anticipation of the missile strikes. Then they retreated because U.S. and Chinese authorities once again released economic data that disappointed those expecting more robust economic indicators and basing their oil demand outlook on those.

At the start of this week, we saw another jump in oil benchmarks based on expectations of a hotter war in the Middle East. Then, hours later, OPEC revised its oil demand forecast for the year lower, pushing prices back down. The revision was not major – OPEC now expects oil demand growth at 2.11 million bpd, down from 2.25 million bpd, but it was enough to spook traders—again.

Reuters’ market columnist John Kemp reported this week that oil traders had been net sellers of crude futures for five weeks in a row. As of August 6, institutional traders’ net positions across the six contracts had fallen to the lowest since 2013, when records of these trades started. Since the start of July, the data showed, traders’ oil positions had dropped by 372 million barrels of oil equivalent.

According to Kemp, the reason for the selloff, in addition to worries about the world’s biggest economies and their growth prospects, is anticipation of softer oil demand in the future. This anticipation may well be driven by transition forecasts—which have consistently failed to materialize. But traders are using algorithms to make their bets, and those algorithms can turn a market bearish in a flash.

Bloomberg reported earlier this month that algo trading, where traders rely on software tracking market trends, had been responsible for the fast sentiment change on oil markets following the stock market quake last week. At the time, U.S. and Chinese economic data had reignited doubts about the future strength of oil demand, and algo traders had started selling, leading to a price rout in crude. 

This was not the first time algo trading has affected prices in what appears to be an excessive way. In June, an OPEC announcement that it may start rolling back some production cuts later in the year triggered an oil selloff, again led by commodity trading advisors following trends. The market reaction to the news was clearly excessive, in light of the fact that OPEC said it would only roll back the cuts if the market conditions suited it—but that got ignored by algorithms.

It could be the case that algorithms—and the CTAs that work with them—are bearish on future oil demand because of the EV boom forecasts. The actual facts are that EV sales are slowing down and even declining in some key markets, such as Germany, but as governments double down on transport electrification, the forecasts remain upbeat for EVs and bearish for oil.

This is perhaps why traders appear to consistently ignore the supply side of the oil equation until such time as an outage occurs, reminding them that this side still exists. Yet even with outages, such as the one at Libya’s Sharara, the effect on prices does not seem to last long, and prices tend to retreat relatively quickly. Unless it’s a large one—and that is why prices are up this week. If the war in the Middle East heats up, it could affect the supply of 1.5 million bpd from Iran. That may be something not even CTAs would easily ignore.

By Irina Slav for Oilprice.com

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