The “boyz” are at it again. Trend-following hedge funds are piling into the short oil trade.
In late November, bets on lower oil prices were at a high for the year, equivalent to 3.5 days of total global demand.
The short futures and options positions on North Sea Brent oil are at the highest since October 2014 at 141 million barrels.
Similar shorts on West Texas Intermediate (WTI) crude stood at 172 million barrels on December 1.
That’s doubled over the past seven weeks. WTI shorts are at the third-highest level ever, with the two highest levels set earlier this year.
Such a massive one-way bet – about 300 million barrels – sets up the oil market for a brutal short-covering rally, and perhaps more…
The nervousness surrounding the oil market is apparent when you look at the options trading on oil.
Reuters columnist John Kemp pointed this out, saying that implied volatility for at-the-money Brent crude options was in the 86th percentile for all trading days since 2006.
The implied volatility since 2006 has been just under 31%. In early December, it was at 44%, which puts it at 1.5 times higher than normal.
Which means something bad – large spikes upward in price – could happen.
Trend-following hedge funds, unlike macro hedge funds, don’t often look at the big picture. To them, geopolitical risk doesn’t exist. Only the charts. So there’s no consideration of possible geopolitical risks baked into their bets on oil prices.
Geopolitics: Russia/Turkey Version
But there are major geopolitical risks associated with all the players now involved in the Syrian conflict.
After the downing of a Russian jet by Turkey, Russia pulled no punches in saying that Turkey’s leadership is in bed with ISIS, ISIL, Islamic State, Daesh… whatever you want to call those barbarians.
Maybe Putin read the Harvard speech given by Vice President Joe Biden in October 2014. Biden said that the regime of Recep Tayyip Erdoğan was backing ISIS with “hundreds of millions of dollars and thousands of tons of weapons.”
Biden later apologized and the speech was quickly forgotten by the mainstream media.
But doubts linger about Erdoğan and his family.
Stories continue to proliferate in media outside the United States that Erdogan’s son and daughter – Bilal and Sümeyye – are involved with ISIS.
Bilal owns several maritime companies. The companies allegedly carry stolen Iraqi oil on their ships to ports around the globe. (“Stolen Iraqi oil” being the polite term for ISIS oil.)
Meanwhile, Sümeyye is rumored to be running a secret hospital camp just over the border from Syria in Turkey for wounded ISIS fighters.
True, or Russian propaganda? Only the Erdoğans and ISIS know, and they’re not talking.
But there’s certainly no denying that Putin and Erdoğan are cut from the same cloth. Both are highly autocratic rulers that their peoples compare to illustrious predecessors – czars and sultans with their calls to restore past national glories.
They also don’t back down from a fight. This may not be Hitler-Stalin, but it still isn’t good for stability in the oil-rich region.
So how do you play oil for a potential long-term deterioration in the geopolitics of the Middle East?
My preference would be to own major oil companies with exploration success. To my surprise, the leaders come from Europe.
Thanks to use of one of the world’s fastest supercomputers, the leader is Italy’s Eni SpA (E). The company has spent about $41 billion on exploration since 2005. But it’s been rewarded with finds equivalent to 18 billion barrels of oil. That’s more than double No. 2, Statoil ASA (STO).
Both stocks are, of course, beaten down in price, and may now be worth a look.