Commitment Issues
Commitment Issues
Contextualizing the data behind the record two-week reduction in speculative net-positioning in major crude futures and options contracts that prompted the recently overdone price collapse
This post is the first in what will be a series of posts focusing on the supply of and demand for paper barrels, which are obviously related but inherently distinct from the fundamental realities of the physical market.
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In addition to being the world’s largest physical market, the oil market is also a paper market where prices emerge from the buying and selling of futures and options contracts—and it plays the most immediate role in driving the prices on your screen week-to-week.
We’ve just seen a record two-week reduction in speculative net length in crude contracts that prompted a rout that battered oil prices in March, but this paper move also sowed the seeds to the inevitable price rebound.
In this way, we can use the Commitments of Traders (CoT) report, and specifically the relative positioning of various major trader categories, to provide critical understanding for this latest price rout and the balance of positioning risk going forward.
The oil market is the world’s largest and most valuable physical commodity market, dominated by the fundamental realities of supply and demand. But the oil market is also a paper market where prices emerge from the buying and selling of futures and options contracts. While the settlement of some paper contracts result in the actual delivery of crude, the vast majority do not; instead, these contracts are used either as a financial hedge for producer and consumer risk or to speculate on future price movements. Oh, and the paper market is much, much larger than the physical trade in barrels.
Supply and demand data paints a picture of how the physical oil market is evolving over a period of time. Likewise, positioning data captures how market participants (speculators vs. commercial operators) are positioned (long vs. short) in the paper market. Now, I firmly believe that the price of major crude benchmarks, like Brent and WTI, don’t materially deviate from fundamental physical realities for long but, still, the paper market plays a much more proximate role in driving the oil price on your screen week-to-week.
The current market serves as just one example: At the beginning of March, days before the collapse that ultimately took Brent prices $17/bbl lower over two weeks, I wrote that “heightened bullish positioning like we’re seeing in Brent blunts upside potential given a lack of readily available incremental buyers and increases downside risks given the propensity to take profits.” The following week, after some price weakness but before the big drop to come, I stressed this warning once again by saying that bullish positioning in crude contracts “increases the risk of sharp, capricious selloffs”—and boy, oh boy, were the $10+/bbl declines that following week both sharp and capricious.
Of course, it’s important to understand that positioning data aren’t deterministic and of questionable value in timing price movements; rather, they provide critical context on who has been driving prices to where we find ourselves today—think of it more as situational awareness.
So, let’s better understand the Commitment of Traders (CoT) report (aka the main source of positioning data), the role of speculators in price formation, and how this information can help us understand both how prices have evolved and the flavor of the positioning risk backdrop going forward—a great example of this value was as a leading risk indicator in the run-up to this latest severe crude price rout.