Oil Slides As U.S.–Iran Deal Sparks Hope, But Risks Remain

Energy futures are dropping by 3-5% this morning, and in many cases reaching their lowest levels since early March, after the U.S. and Iran both signaled that an agreement to end the war had been made over the weekend. The official signing of that deal is expected on Friday, and while most ships are still not transiting the Strait of Hormuz, the “actual” deal that’s been promised for more than a month seems to be good enough for now to keep up the selling pressure after chart support broke down last week.

Meanwhile, if you’re in the believe it when I see it crowd, you may note that Israel was not a party to the agreement, and reports this morning say that they are not planning to end their war with Hezbollah or pull forces out of Lebanon.

While futures are showing great enthusiasm for the end of the war, and the (eventual) reopening of the world’s most strategic waterway, physical markets will need much longer to recover, with shipping activity likely to take 3-6 months to get back to normal, and the re-stocking of inventories drawn down during the shut-down likely to take years.

Hedge funds have been buying the peace story the past couple of weeks, meaning they continued to sell long positions in energy contracts and add new shorts in anticipation of the price drops we’ve seen over the past week. Last week’s CFTC data (compiled with Tuesday’s positions) showed a huge drop of nearly 44,000 contracts in the large speculative net length in Brent crude with 27,000 long positions sold, and nearly 17,000 new contracts added. Textbooks will tell you that anytime the large speculative trade category gets into an extreme position one way or another that’s a contrary indicator and a signal the market is about to reverse course. That proved true at the start of the year when Money Managers amassed the largest ever short position in Brent and WTI combined just in time to get run over by the largest supply disruption in history. While the recent additions to short positions in Brent are certainly noteworthy, they’re still about 75,000 contracts shy of what we saw at the peak in December, and WTI shorts are much more modest.

The positioning in refined product contracts have been much more subdued than what we’re seeing it Brent, with changes of just a few thousand contracts in total. Hedge funds have also shown a lack of enthusiasm for credit contracts, with only small moves in RIN, LCFS and Carbon Allowance contracts in recent weeks. Most notably, the large speculative trade category known as Money Managers saw its net length in D4 RINs touch a 16 month low last week, even as values held at all-time highs.

Baker Hughes reported a net increase of 2 oil rigs drilling in the U.S. last week, marking a 7th consecutive week of increases. While many believe the recent uptick in drilling will lead to record U.S. oil, natural gas and NGL production next year, it’s worth noting that the off-shore rig count has dropped to a 3 year low during this stretch, which suggests not everyone is wildly enthusiastic about adding more production. The natural gas rig count declined by 3 last week, which suggests some gas producers recognize that the increase in onshore oil drilling means more natural gas will come along for the ride. The Primary Vision count of fracking crews active in the US ticked up by 2 last week, matching the 1-year high set 2 weeks ago.

Delek reported an equipment malfunction at a sulfur recovery unit at its 73mb/day Big Spring TX refinery Sunday, adding to a string of hiccups in the W. Texas and New Mexico markets that’s keeping regional supplies uncomfortably tight.