The drop in oil prices has been stunning, with both U.S. and international crude pushing a 40 percent decline since June. Attention so far has been on supply and demand getting out of whack: The world has more oil than it actually needs, with various estimates of the surplus falling anywhere from 700,000 to more than 1 million barrels of daily production.
The U.S. is mostly to blame. The shale boom has poured an extra 4 million barrels of oil into the world since 2008. That helped the market weather chaos elsewhere, keeping oil prices remarkably flat. But the trend has been clear for a while now, and plenty of smart analysts have been talking for more than a year about the potential for much lower prices.
The first people to act on that view were speculators—people, in other words, who want exposure to oil prices without having to take delivery of the physical crude, if they can help it. The government terms this group managed-money traders, which includes hedge funds or anyone else who trades “on behalf of investment funds or clients.” By June, the speculators had amassed a huge long position in oil futures, essentially betting that the threat in Iraq of Islamic State and sanctions against Russia would drive prices higher.
Across crude oil, heating oil, and gasoline, speculators by June 24 were collectively long a net 813,566 futures contracts. That’s the equivalent of 813 million barrels, or about 9 days’ worth of global oil consumption. It’s also a record, says Timothy Evans, who tracks the weekly changes for Citi Futures.
Since then, there’s been a dramatic rush for the door, with money managers liquidating more than 550,000 contracts. Combined with some short selling, the speculators are now net long just 234,000 contracts. Since June, then, speculators have dumped the equivalent of 500 million barrels of oil onto the futures market. Here’s what that looks like in the Brent crude contract traded on the ICE exchange:
Most of the selloff happened by the end of September. Speculators are still net long oil, which means a collective expectation remains that prices will rise. Last week actually saw an increase in oil futures after the OPEC decision not to cut its production.
For the flip to be complete, money managers would have to be net short, meaning they were all betting on a continued decline. According to Evans, the last time speculators were net short crude oil was in September 2003, when it was about $25 a barrel. That didn’t turn out so well for a lot of them: Within a year, oil was at $40. With a projected surplus that could average something like 1.3 million barrels a day, Evans says it’s going to be a while before fundamental pressure reaches the point of pushing prices back in the other direction, which would probably happen through some combination of rising demand and lower levels of production.
Not everyone got out in time for oil’s current swoon. A handful of big commodity hedge funds have shut down this fall in part due to oil prices. Hall Commodities, a $100 billion hedge fund in London, closed in October, and the $37 billion Brevan Howard hedge fund is reportedly shutting its commodity fund.
Oil speculators hold a special place in the minds of a lot of people, who see them as somewhere between the devil and heartless capitalists manipulating the world’s most important market. Speculators certainly help influence prices, for good or bad. In 2012, when nerves were on edge over putting more sanctions on Iran for its nuclear program, speculators helped fuel a sudden runup in prices. They also played a role in driving up prices in 2008.
Mostly they’ve been blamed for making prices go higher. This time, though, the opposite is true. John Kilduff, a partner at Again Capital, an energy hedge fund in New York, isn’t expecting to be thanked soon. “I’m still waiting for Congress to erect us a monument for breaking the back of high oil prices,” he said.
