Traders are betting that OPEC will stick with its output cuts, but they are also wary of a sharp reversal of crude’s rally
Bullish bets on oil rose to a record in January, reflecting widespread optimism that crude prices are poised to move higher as OPEC starts cutting production in a bid to ease a global supply glut.
Wagers on rising U.S. oil prices have more than doubled in less than three months. Investors have turned more bullish since the Organization of the Petroleum Exporting Countries in late November reached a deal to cut output.
Long, or bullish, positions last week exceeded short, or bearish, positions by 370,939, marking the largest net bullish position in 10 years of data from the Commodity Futures Trading Commission. That compares with a net bullish position of 159,415 contracts in early November.
To put the size of the bullish position in context: The more than 420,000 bets on rising oil prices in place last week represented nearly all the crude held in U.S. commercial storage tanks.
That is a sign of faith that the nearly yearlong oil rally has more room to run. But the bullish slant to the market is a concern for traders, who worry that a dimming of the market’s view on oil could prompt a rush for the exits and intensify any selloff.
The last time speculative investors were close to this bullish on oil was in June 2014—when Islamic State militants began threatening major cities in Iraq. That was a few weeks before the market began a 20-month-long slide. The historic selloff sent oil from above $100 a barrel to a decade low around $26.
Investors continue to pile into long positions even though the oil rally has been on pause in the past seven weeks. Volatility has plummeted to a two-year low. U.S. prices stayed within a $3 range throughout January as traders awaited confirmation that promised cutbacks from members of OPEC would materialize.
Data on OPEC’s compliance recently has started to trickle in. The cartel is on track to meet 75% of its promised cuts, according to tanker tracker Petro-Logistics. Other firms have put the rate even higher.
Those levels are well above the producing group’s typical compliance with quotas, analysts say, which helps explain why so many investors are bullish.
Oil prices rose 18 cents to $52.81 a barrel Tuesday after OPEC production data lent further support to the belief that the group was abiding by its pledge to cut output.
Will Riley, a portfolio manager with Guinness Atkinson Asset Management, said he expects crude prices to rise because he thinks OPEC members are likely to keep complying.
“I don’t think they are satisfied with the current [oil-price] level,” Mr. Riley said. “It leaves almost all member countries running a significant fiscal deficit.”
OPEC’s agreement runs through June. The prospect of an extension of the curbs in May is another reason investors are reluctant to bet on lower prices, said Nick Koutsoftas, a portfolio manager with Cohen & Steers. Mr. Koutsoftas has placed bullish bets on oil in recent weeks.
If OPEC prolongs output cuts, that could cause stockpiles to decline and send oil toward $65 by year-end, he said.
But some traders say the lopsided market raises the likelihood of a sharp reversal. Cascading sell orders could quickly sink prices, they say.
“It’s going to be harder and harder to get the market higher when the market is already so long,” said Kathleen Kelley, chief executive of Queen Anne’s Gate Capital Management, a commodities consulting firm. “The market is really vulnerable here.”
The possibility of a sudden selloff and high inventory levels point to a modest risk of price declines for oil and put limits on the upside, analysts at Goldman Sachs Group Inc. wrote in a research note Sunday. The firm predicted that recent choppy price action around $55 will continue.
There is an expectation that OPEC will continue to abide by its agreement, said John Pickart, a commodity fund manager with Franklin Templeton Investments. “But if there’s any whiff of it not happening, there’s a lot of positions there that can get unwound.”
Other forces could keep oil prices in check. U.S. crude producers are looking to lock in prices in an effort to ramp up production, which could exert downward pressure on prices. The number of short positions held by producers, which use the contracts to hedge, is near decade-high levels, according to CFTC data.
Stockpiles are still near record levels world-wide. In the U.S., inventories have been growing. They likely have to fall before oil prices move significantly higher, traders said.
Mr. Koutsoftas at Cohen & Steers said a negative headline could weigh on crude prices, but he isn’t planning to bail out quickly. “If that were to happen, I would see it as a buying opportunity,” he said.