Oil has been a headline topic for investors going on more than two years now. The price war waged by OPEC against foreign producers like US shale in order to maintain market control has resulted in a massive supply glut and has trashed the energy sector. But the war could be over soon.
Keeping oil prices so low has hurt not only foreign oil producers but also OPEC countries. Saudi Arabia is facing political problems due to its actions, while Russia is on the verge of going broke. The House of Saud has made statements indicating that it intends to take actions to return oil to trade on a fundamental supply-and-demand basis instead of leaving it under the control of the OPEC cartel’s price manipulations.
OPEC’s grip on oil is almost gone and a new paradigm is just around the corner. The global economy, once seemingly on the verge of a recession, seems to be picking up steam again. The Fed announced the possibility of a rate hike soon—something investors thought would happen in December at the very earliest. The oil trade is gearing up for a big change, and Wall Street has already taken notice.
Wall Street's Big Oil Bet
Hedge funds are known for being the elite traders on Wall Street. They set the tone for all other traders and make moves well in advance of anyone else picking up on emerging trends. So when these giants of investing start throwing around money, it’s bound to attract attention.
Right now, money managers are doubling down on oil going higher. At the end of last year, hedge funds were net long 242 million barrels; as of March 22 this year, they held 579 million barrels. Short positions in oil have been drastically reduced in favor of more bullish contracts, and the oil market has responded in kind jumping up around $10 per barrel in the past two months.
Although oil typically rises during the summer months, the drastic price increase can be at least partially attributed to the large number of bullish bets being placed on it. Time will tell if the jump will stabilize or if it’s just a temporary boost before retreating back down to the $40 range. But oil has been slowly recovering its lost ground all year, and by the end of 2016, a $50-plus oil price is a very likely scenario.
Although most analysts expect oil to keep going higher as time goes on, there are still some downside risks out there. Economic sanctions on Iran—Saudi Arabia’s biggest political rival—have been lifted, and agreement talks between the two countries have fallen short. Iran has already begun ramping up production in an effort to start exporting oil again, flooding an already over-saturated market.
Even if Saudi Arabia manages to curtail OPEC’s oil production and makes strides to ensure that oil trades by the laws of supply and demand, Iran will remain a variable that isn’t likely to cooperate with other major oil producers. It’s too early to tell what direction the new oil market will go and what it might look like, but it seems safe to say that the days of oil volatility aren’t yet behind us.