The market reaction to OPEC’s latest production policy announcement was extremely negative, partly due to the many trades executed based on trend-following algorithms, analysts say.
While most analysts view the OPEC+ alliance’s announcement this weekend as bearish for oil prices towards the end of the year due to the plan to start unwinding some of the cuts as early as October (market conditions permitting), Oil’s price movement early this week was likely exaggerated, observers and analysts said.
Algorithmic traders are dragging oil prices too low
Because algorithmic traders do not adhere to the basic principles, but rely on rules-based computer formulas to execute trades, they have further strengthened the already bearish sentiment in the oil market.
Algorithmic trading uses algorithms, computer programs that follow a defined set of instructions, to place a trade. And the growing group of commodity trading advisors (CTAs) who have trend-following trading strategies have been pushed to sell oil by these algorithms.
This was partly the reason for the oil crisis on Monday and Tuesday, after OPEC announced on Sunday that it would extend most production cuts until 2025, but could start phasing out some voluntary cuts after the end of the third quarter of 2024 , depending on market conditions.
Related: OPEC+ reassures oil markets and eases concerns about oversupply
OPEC’s announcement was seen as bearish for the market and negative for oil prices, but algorithmic traders have also exacerbated the price decline.
As a result, oil prices hit a four-month low and Brent crude oil prices fell below $80 per barrel for the first time since early February.
The trend-following CTAs reversed their positioning in Brent Crude this week to a net short position – the difference between shorts and longs – from a net long position – in which bullish bets were higher than bearish bets – late last week, according to data from Bridgeton Research Group, cited by Bloomberg.
“CTAs are just crushing the market with massive selling,” Scott Shelton, an energy specialist at TP ICAP Group Plc, told Bloomberg earlier this week.
These massive selling added to the bearish sentiment amid fears of weak demand growth putting pressure on oil prices, which lost 5% in just two days after OPEC announced its production plans for the coming year.
Many CTAs were pushed by algorithms to significantly increase their short positions in crude oil futures, Swissquote Bank senior analyst Ipek Ozkardeskaya wrote in a MarketWatch note.
Options trades also worsened the oil price path, according to analysts.
The movements of CTAs “amplify market movements because they tend to sell into a bear market and buy into a bull market,” Ozkardeskaya wrote in the note.
“That’s why the latest sell-off may be overdone.”
Oil sell-off exaggerated
Oil’s sell-off this week is overdone, ING’s commodity strategists Warren Patterson and Ewa Manthey wrote in a note on Wednesday.
“OPEC+’s decision warrants relatively more weakness further down the forward curve (we currently see a small surplus in 2025 with the gradual return of OPEC+ supply), but speculative money will largely be positioned for the foreseeable future,” they said .
Technical signals also indicate that the oil market is now entering oversold territory, but weakness in refinery margins remains a concern for the market, ING strategists believe.
Commodity analysts at Standard Chartered also pointed out that the oil price drop on Monday and Tuesday was the result of markets being dominated by a combination of extreme macroeconomic pessimism, speculative short positions and over-enthusiastic algorithmic trading, crowding out more fundamental traders.
Oil prices recovered on Wednesday and were higher in Asian trading early on Thursday as the market shrugged off the sell-off. Oil rose from a four-month low amid growing optimism from a Reuters poll that the Fed could cut rates in September.
Despite a rise in U.S. commercial crude and gasoline inventories, oil prices saw an “oversold rebound after ending lower for the fifth day in a row on Tuesday,” Fawad Razaqzada, market analyst at City Index and FOREX.com, told MarketWatch.
“It remains to be seen whether this recovery will continue given ongoing concerns about demand concerns and OPEC+’s decision to ultimately phase out voluntary production cuts at a time when non-OPEC supply is increasing” , the analyst added.
Most analysts do not think there would be market conditions in which the OPEC+ group would gradually start increasing supply in the fourth quarter of 2024.
Mukesh Sahdev, Senior Vice President and Head of Oil Trading/Downstream Solution at Rystad Energy, commented: “The bottom line is that the OPEC+ math appears to be an OPANE math.”
Demand and market balances in the third quarter could be tempting for a reversal of cuts from October, but OPEC+ is likely to consider balances for the fourth quarter and beyond, Sahdev says. According to Rystad Energy, these balances are expected to consist of flat demand growth in the final quarter of the year, a decline in crude oil demand at refineries and nearly 1 million barrels per day growth in crude oil supply non-OPEC+ countries.
“The fundamentals for 2025 do not provide a strong signal for a reversal of the OPEC+ strategy,” Sahdev noted.
By Tsvetana Paraskova for Oilprice.com
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