The Short Squeeze In Oil



Apparently hedge funds and other savvy institutional investors, betting on an economic decline in the United States did indeed take large short positions in oil. The following information, which was produced by the International Energy Agency, lends support to the positions these savvy investors took.

“January world oil supply rose 745 kb/d to 87.2 mb/d on new output from Brazil, and recovering non-OPEC output elsewhere. However, a reassessment of 2008 prospects lowers OPEC gas liquids growth by 250 kb/d to 365 kb/d. Rising FSU, Asia-Pacific, Brazil and biofuels supplies generate 2008 non-OPEC growth of 0.97 mb/d.”

“Global oil product demand has been revised down by roughly 200 kb/d to 87.6 mb/d in 2008, following weaker GDP growth figures in an interim report by the IMF. Weaker OECD growth, however, stands against still-robust projections for GDP growth in China and the Middle East, the key oil demand growth centres. [1]”

Let’s read the items highlighted in bold again and put it together in one succinct sentence: January world oil supply rose while global oil product demand fell. Under the all things being equal principle, that all to fallible statement, one would expect near term declines in the price of oil. As we now know, that didn’t happen. According to an article today in the Financial Times, “efforts to drive prices below $87 were met by substantial consumer buying. [2]” Combined with disruptions in production in Nigeria and Hugo Chavez’s threat to cut supply to Exxon Mobile, a short squeeze pushing oil past $100.00 occurred. Today also marked an options expiration day for oil contracts forcing all the shorts to cover their positions. While oil may run past $100 to $110 or higher given the purchase of options contracts with a strike price as high as $120, I simply can not believe that these prices will stay there. The United States economy is slowing. The Indian economy is slowing (though still growing at a rapid rate - more that this in another post). Supplies are rising. These fundamentals can not support prices above $100. At least conventional reasoning suggests they shouldn’t in the long run. A note to the wise though - don’t ever try to fight the trend. If you believe in Technical Analysis, oil looks likely to break out.

[1] International Energy Agency - Oil Markets Report
[2] Oil’s rise to $100 catches hedge funds short

February 21, 2008 | Filed Under Commodities, Energy, Etc 

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