One recurring theme observed throughout the oil rally since the February 13 year lows, has been increasingly more aggressive hedging action by producers, who are willing to give up upside gains in order to protect from yet another swoon lower in prices. And, as Goldman cautions in its latest note on ongoing imbalances in the oil market, "the rally in long-dated prices has taken prices to levels ($50/bbl in 2017) where hedging activity is ramping up which suggests it will soon stall."
This can be seen in the following chart of overall hedging activity by oil explorers which as of this moment is the highest since mid-2011.
Overnight Bloomberg confirmed this trend when it reported that producers and merchants increased their short position in WTI by 3.8% for the week ended May 10 to the highest since September 2011. It adds that "oil producers are taking advantage of the rebound in crude markets to lock in protection against another slump. They increased their bets on falling prices to the highest level in 4 1/2 years as U.S. inventories of stored oil remained near an 87-year high, while a natural disaster in Canada and militant attacks in Africa curtailed output. Negative sentiment among the group expanded for a third consecutive week, the longest streak since February."
Energy companies from EOG Resources Corp. to Chesapeake Energy Corp. used financial instruments such as futures, swaps and collars to guard against another fall in prices. West Texas Intermediate oil, the benchmark U.S. crude, has gained more than 75 percent since hitting a 12-year low in mid-February.
As Again Capital's John Kilduff chimes in producers "have been getting more and more active in hedging ever since the first initial jump," adding that they "appear to be drawn to this market as everyone tries to stay alive through the downturn."
For now, however, the market is less focused on what oil producers themselves are expect from the future price of oil, and far more concerned with transitory oil disruptions in the crude market as highlighted by Goldman, and which as we observed earlier, has taken out about 1.5 million barrells from the market for the time being.
At some point in the coming days, attention will return to oil hedging, which appeared to be finally driving prices last week, although today's news have pushed oil to fresh 6 month highs. "The failure to rally on bullish news was a bearish indicator, at least for a handful of sessions,” said Tim Evans, an energy analyst at Citi Futures Perspective in New York. "The market still looks relatively overbought."
As Evans adds, "Some subset of managed accounts have been trying to pick a top in crude. We’ve been rallying for months so the question is, 'Are we in the middle or late stages of the rally?'"
Our own view is one we shared a month ago: the price action this summer will closely follow that of the summer of 2015, at which point all the relentless hedging will allow US production to be unleashed, and crush Goldman's near-term rebalancing thesis, and lead to millions more barrels coming online, potentially at the same time as all the temporary oil market disruptions are also normalized. Unless, of course, some central bank openly admits it will begin monetizing oil in which case all bets are off.
On the other hand, one oil and gasoline prices anniversary their base effect and start rising, it will be interesting to watch the Fed and central banks respond as energy prices suddenly spike, sending various CPI indicators far higher and forcing a return of the infamous tightening language.