Earlier today, we brought you the latest from Vienna, where OPEC and allied producers are struggling to figure out how to announce a production cut without infuriating Donald Trump, who took to Twitter as soon as headlines crossed that the cartel and Russia have agreed to a whisper number production cut of 1m b/d.
To be clear, OPEC+ has to do something to allay market concerns after last month’s rout. The problem is that Trump’s increasingly incestuous relationship with the Saudis and vocal opposition to price stabilization is complicating the situation immeasurably.
Long story short, the market expects a cut of at least 1m b/d and the nuance around how any cut will be implemented will be important to how the market perceives whatever OPEC and Russia collectively decide.
As we mentioned earlier, crude volatility remains elevated headed into Thursday and we thought this was an opportune time to highlight some commentary from BofAML regarding some of the points we (and plenty of others) made last month on the three days when the bottom fell out for WTI in earnest.
For those with a short memory, crude suffered its three largest one-session declines since 2015 all in the space of just 10 days, and while a variety of fundamental/macro factors conspired to push oil into a bear market, those three sharp declines were the direct result of trend followers pushing prices into key strikes associated with producer hedges. Dealers who sold those puts were then forced to dump more and more crude to stay hedged themselves, exacerbating the declines.
There were civilian casualties (figurative speaking, of course). Lurking in the background as crude collapsed was a large long WTI/short nat gas bet, which blew up in spectacular fashion. The ripple effect of that unwind in nat gas, led to the demise of optionsellers.com, a sad tale we recounted on November 17.
Read the entire “death blow” saga
In a note dated December 4 (which is essentially just an OPEC preview), BofAML recounts how CTAs and gamma effects exacerbated the situation for crude in November.
“Who was selling oil in the past few weeks?”, the bank asks, before noting that “it’s useful to start by looking at our CTA as well as systematic asset allocation strategy models.”
Why, yes – yes we imagine that would be “useful”.
But before we get to BofAML’s models, let’s review a couple of simple charts, ok? The first is just the SG Commodity Trend Following Index. See if you can spot the moment when CTAs flipped bearish (hint: it’s highlighted for you):
Funny how a commodity trend following strat falls during crude’s initial selloff and then suddenly blasts off about halfway through a record-setting series of daily declines. Here’s the SG CTA index’s rolling beta to WTI:
That looks like at least some trend followers flipped short.
“On our estimates, CTA positions have shifted very rapidly from being quite bullish to outright bearish while we also estimate that systematic asset allocation funds have likely reduced their commodity exposure by 1.5%”, BofAML writes, in the same note mentioned above, before observing that “on a net basis, systematic asset allocators and CTAs probably sold $40bn worth of oil in the past two months.”
There you go. So, $40 billion sold pushes oil into key strikes where producers are hedged and then, cue the gamma effects.
“Large put option purchase programs exceed 500 million barrels at Brent equivalent strikes likely around $55 to $65/bbl”, BofAML goes on to say.
And if you want the specifics, they’ve got ’em for you. “In particular, the large Mexican and Brazil sovereign oil hedges may have exacerbated short futures selling in the market, with positions as a percentage of daily turnover increasing very quickly in the past two months”, the bank notes, referencing the following set of visuals.
To be clear, BofAML is bullish from here and sees Brent back at $70 in 2019. The bank is also quick to note that while the above-mentioned technical factors certainly played a role, most of the selloff was due to fundamentals.
Still, these kinds of “behind the scenes” snapshots following outsized moves in critical assets are important as they help to explain what, to the general investing public, probably seems completely inexplicable on certain days.
And see, that’s what you have to keep in mind if you’re, say, a commodities analyst, a reporter whose beat is oil or, especially, a trader. All of the above might seem obvious to you, but trust us when we say that to the average investor (and really, even to the average 20-something on Wall Street), the succession of egregious one-day declines in WTI last month and the concurrent rip in nat gas was anything but “obvious”. Just ask any former client of optionsellers.com.
Now let’s see what OPEC comes up with. Make sure and tune in to Twitter where noted commodities strategist Donald Trump (of 1600 Penn. Asset Management) will be blasting out hot takes in something that approximates real-time.