Investors Flock Back Into Oil for Reflation Trade, Hedging

(Bloomberg) -- Investors and oil companies are rushing back into the crude market.

Total holdings of Brent and WTI futures have climbed to the highest level since May. It comes as banks from Goldman Sachs Group Inc. to JPMorgan Chase & Co. see the market’s prospects brightening and some big hedge funds talk of commodities entering a pricing super-cycle.

The surge in open interest marks a turnaround from the aftermath of oil’s crash below zero, a rout that spurred a collapse in global crude production at the same time as plunge in consumption. Trading slumped last year as U.S. crude production dived and consumers such as airlines pulled back from the hedging space. The nadir was November. Since then, things have picked up, with a sharp rebound this year.

“People are reconsidering the investment case for the commodities asset class,” said Harry Tchilinguirian, oil strategist at BNP Paribas. “Open interest in oil is rising again as macro-oriented funds look at the case for commodities.”

JPMorgan is among banks saying it favors commodities as a hedge against inflationary pressures while Bank of America Corp. thinks reflationary pressures are already helping to push oil prices higher.

Recovery

The rally has also spurred an uptick in producer hedging, with WTI for 2022 nearing $50 a barrel. Brent for the same period is already above that marker. A big chunk of shale oil production is profitable at current levels, according to International Energy Agency Executive Director Fatih Birol.

Alongside the recovery in activity, there’s also been a rebound in the number of bullish market participants. There were 163 money managers with long positions in Brent and WTI last week, the most since February. That’s up from a low of 94 in March.

The shift is good news for CME Group Inc. and the Intercontinental Exchange Inc., which own the world’s biggest oil exchanges.

“Our WTI markets continue to reflect broad participation across the world as customers manage their global price risk,” said Peter Keavey, managing director of energy products at CME Group. “WTI remains the market’s choice for managing crude oil exposure.”

Crude has had more reasons to be buoyed so far this year. A huge index rebalancing was expected to see about $9 billion flow into the market last week, as prices rallied to 10-month highs. In addition, weakness in the dollar is spurring renewed talk of a commodities super-cycle. Both JPMorgan and Goldman Sachs recommended boosting exposure to the sector in recent days.

There’s “plenty of producer hedging of course and some of that will in some form go on exchanges,” said Paul Horsnell, head of commodities research at Standard Chartered Plc.

In addition, short positions of swap dealers -- a sign of banks managing the hedges they sold producers -- rose to their highest level since April last week.

And with forecasts of a global economic recovery this year, there are potentially more inflows to come for oil. The value of Brent and WTI open interest is still down about a third from a peak of $408 billion in 2018, but the World Bank expects a 4% growth in global economy this year, and a 7.9% climb in China, the world’s largest oil importer.

“Brent is the global benchmark for crude oil pricing so, as forecasts for global economic activity improve, we’re seeing strong demand for trading and risk management via the Brent futures market,” said Jeff Barbuto, global head of oil markets at ICE.