(WCTW) A Short Squeeze In The Making, But Pay Attention To The Signals After That

At this point, unless you are living under a rock, you will probably know that money manager positioning in Brent went into the negative for the first time in history.

Source: John Kemp

The oil market tends to swing to the extremes, and in this case, the pessimism on 2025 oil market balances has swung too far. For those that have gone through the wringer, you may remember at the end of 2023 when the market became overly pessimistic on Q1 2024 balances.

On Dec 6, 2023, we published a piece titled, "Speculators Gone Wild." In it, we said:

With a bit of reversion in short positioning + a tighter physical oil market backdrop, we believe WTI has room to rally to $81/$82 with Brent to $85/$86. For the moment, that's likely to be the peak given the "perception" around Q1 2024 balances.

Now if Q1 balances don't build meaningfully, the market will push higher this limit. For us, the easiest way to figure out when crude has topped out (in the range) is when refining margins start to fall. Once you see that, you know that's likely a short-term ceiling.

Keep in mind that global refineries enter maintenance in February to March, so margins should remain elevated from now until then.

All in all, we expect oil to have bottomed here. Crude backwardation should return shortly with refining margins leading the charge higher. We think OPEC+ compliance will be high further preventing any bearish global inventory builds in Q1. Speculator short positioning will reverse further fueling the tailwind in oil. For readers looking to allocate into energy names, now is the time.

Looking at WTI's chart, the bottoming process took another 10 days or so. After that, WTI was volatile but steadily trended higher. And thanks to hindsight, Q1 2024 balances failed to build leading to oil prices meaningfully appreciating by the end of March.

Similarly this time around, speculator positioning is getting near peak bearishness.

Thanks to this chart from Eric Nuttall, you can see that this year's oil price volatility is largely thanks to the sudden whipsaw in positioning from money managers. This is a picture that perfectly captures the asinine ups and downs we've all experienced as energy investors.

As the legendary Stan Druckenmiller once said, "It's all about liquidity." And liquidity flow this year has been downright pessimistic.

But as any prudent reader will ask, what's going to change this bearish perception? China's economic data remains weak, US oil demand is slightly down y-o-y, Europe is in total disarray, and refining margins are low. What's going to sustainably move oil prices higher?

I think those are all fair bear arguments. So this is why following a potential short squeeze, these are the signals we need to watch for carefully.

Signals