COLUMN-Broken Brent, hedge fund noise and static fundamentals: Kemp
Observing Brent in the first two months of 2013 has been a bit like watching a broken barometer. It is not clear what the market has been reacting to, as prices swing to and for, but it certainly hasn't been fundamentals.
Volatility has fallen to its lowest level for almost two decades. But what remains seems to have been induced by hedge funds rather than changes in physical supply and demand.
The now customary rally at the beginning of 2013 started a little later than last year. But between Jan 17 and Feb 8, front-month futures climbed steadily from $110 to more than $119 per barrel, before subsiding with the same steady consistency and ending up back where they started by the start of March .
Ostensibly, the rally was triggered by the strengthening macroeconomic outlook, especially in the United States, after policymakers skirted the edge of the fiscal cliff, as well as improving sentiment in other financial markets. Saudi Arabia's aggressive production cuts between October and December removed fears about a possible crude market surplus and downside risk.
The subsequent price reversal has been attributed to worries about the impact of higher prices on demand and the economy, renewed economic worries stemming from the euro zone, and hints that Saudi Arabia will up production in March and April, as policymakers change course.
Overlaying all these broader factors are continuing problems with production of the four North Sea crude streams (Brent, Forties, Oseberg and Ekofisk) that physically underpin the Brent futures prices. BFOE crudes remain in short supply, keeping the market in a steep backwardation, with futures prices tending to rise sharply in the run up to contract expiry.
But none of these factors can provide a convincing explanation for the behaviour of futures prices so far this year.
FUNDS ARE DRIVING SPOT PRICES
Changes in the macro outlook and sentiment were too tenuous to provide a convincing explanation for an 8 percent rise in prices that took Brent futures to their highest level in nine months. Saudi Arabia's change of production policy also appears too limited to provide a convincing reason for the market's sudden about turn.
Even the physical Brent market cannot explain the sudden price increase and subsequent decline. Widely reported production problems which shutdown the Brent pipeline system last weekend have not produced the expected rise in prices. Instead front-month prices have remained unchanged.
So what has really been driving the market?
The recent rally has looked and felt a lot like the upturns that culminated in May 2010, April 2011, March 2012 and September 2012.
Each rally and reversal has coincided with the accumulation and liquidation of a large number of long futures positions by hedge funds and other money managers, both from existing funds adding to positions and new funds temporarily entering the market.
Each price cycle has been accompanied by a sharp rise and then fall in open interest....MORE
