Crude oil stuck as focus alternates between demand and supply concerns

The 25-dollar slump in global oil prices since the early October high above $95 in Brent helped drive a significant reduction in bullish bets held by hedge funds and CTAs in the futures market from 560,000 contracts (560 million barrels) to a December low at 171,000 contracts, before Red Sea worries helped drive a recovery to 259,000 on January 2. As per the chart below, we find that speculators have not in recent memory started a year with such a low belief in higher prices with the weak positioning primarily being driven by an elevated gross short at 204,611 contracts, the highest since 2016. 

Speculators will continue to play a key role in setting highs and lows in the market. These often momentum following trading strategies tends to anticipate, accelerate, and amplify price changes that have been set in motion by fundamentals. However, being followers of momentum, this strategy often sees this group of traders buy into strength and sell into weakness, meaning that they are often found holding the biggest long near the peak of a cycle or the biggest short position ahead of a through in the market.

The low positioning highlights an energy sector which, given the right circumstances, may rebound in 2024 once the technical and/or fundamental outlook becomes more supportive, thereby leading to fresh buying and short covering. In the short-term however the fundamental outlook does not look strong enough to trigger such a recovery. 

We see an increased likelihood of crude oil staying rangebound in the coming months with no single trigger being strong enough to change the dynamics of a market that has divided its focus between growth worries, not least in China and the USA, as well as rising non-OPEC+ production on one hand and OPEC+ cuts and geopolitical risks on the other. On top of this we may see risk appetite ebb and flow in line with changes in the expected pace of US rate cuts. 

With that in mind, we see Brent crude oil remain rangebound around $80 per barrel during the first quarter with the very weak positioning, OPEC+ production restraint, and incoming rate cuts potentially leaving the risk/reward skewed slightly to the upside. The biggest downside risk being a disunited OPEC+ leading to a collapse in the current agreement to keep production down, and the upside from a major geopolitical event disrupting the flow of crude oil and gas from the Middle East.