Market reaction to OPEC’s latest production policy announcement was overwhelmingly negative, in part due to many trades made based on trend-following algorithms, analysts say.
While most analysts see the OPEC+ announcement over the weekend as bearish for year-end oil prices due to a plan to begin easing some cuts as early as October — if market conditions allow — oil prices are moving early this week. was probably exaggerated, observers and analysts said.
Algorithmic traders are pulling oil prices too low
Since algorithmic traders do not follow fundamentals but rely on rule-based calculation formulas to execute trades, they have exacerbated the already bearish sentiment in the oil market.
Algorithmic trading uses algorithms, computer programs that follow a defined set of instructions, to close a trade. And an ever-growing group of Commodity Trading Advisors (CTAs) that have trend trading strategies have been incentivized to sell oil by these algorithms.
That was partly the reason oil fell on Monday and Tuesday after OPEC said on Sunday it would extend most of the output cuts until 2025, but could begin to unwind some of the voluntary cuts after the end of the third quarter of 2024 – depending on market conditions.
Related: OPEC+ Calms Oil Markets, Eases Oversupply Concerns
The OPEC announcement was seen as bearish for the market and negative for oil prices, but algorithmic traders also exacerbated the price move lower.
As a result, oil prices hit a four-month low, with Brent crude falling below $80 a barrel for the first time since early February.
Trend-following CTAs flipped their positions in Brent Crude to net short positions — the difference between short and long positions — this week from a net long position — in which bulls outnumbered bears — at the end of last week, according to Bridgeton Research Group data cited by Bloomberg .
“CTAs are just breaking the market with massive selling,” Scott Shelton, an energy specialist at TP ICAP Group Plc, told Bloomberg earlier this week.
The massive selloff added to bearish sentiment amid concerns about weak demand growth for 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 strengthen their short positions in oil futures, Swissquote Bank Senior Analyst Ipek Ozkardeskaya said in a note reported by MarketWatch.
Options trades have also worsened the path of oil prices, according to analysts.
Moves by the CTA “amplify market movements as they tend to sell in a bear market and buy in a bull market,” Ozkardeskaya wrote in a note.
“Therefore, the latest sell-off may be exaggerated.
Oil sell-off exaggerated
The oil selloff this week is overdone, ING commodity strategists Warren Patterson and Ewa Manthey wrote in a note on Wednesday.
“The decision by OPEC+ guarantees relatively more weakening further along the forward curve (we currently see a small surplus in 2025 with a gradual return of OPEC+ supply), but speculative money will largely be placed in near-term calls,” they said.
Technical signals also suggest the oil market is now entering oversold territory, but weak refinery margins remain a market concern, ING strategists estimate.
Commodities analysts at Standard Chartered also pointed out that the drop in oil prices on Monday and Tuesday was a result of a combination of extreme macroeconomic pessimism, speculative shorts and overzealous algorithmic trading driving out markets, which pushed out more fundamental traders.
Oil prices rebounded on Wednesday and were higher in early Thursday Asian trade as the market shook off a selloff. Oil rose from a four-month low on rising optimism in a Reuters poll that the Fed could start cutting interest rates in September.
Despite the rise in U.S. commercial crude and gasoline inventories, oil prices “saw an oversold jump after ending their fifth straight day lower on Tuesday,” Fawad Razaqzada, market analyst at City Index and FOREX.com, told MarketWatch.
“It remains to be seen whether this recovery will last, given lingering concerns over demand concerns and OPEC+’s decision to eventually phase out voluntary production cuts at a time when non-OPEC supply is growing,” the analyst added.
Most analysts don’t think the market conditions are there for OPEC+ to start gradually adding supply in the fourth quarter of 2024.
Mukesh Sahdev, Senior Vice President and Head of Oil Trading/Downstream Solution at Rystad Energy, noted that “The bottom line is that the math of OPEC+ appears to be UNCLEAR.”
Demand and market balances in the third quarter could be tempting to reverse the October cuts, but OPEC+ is likely to consider the balances for the 4th quarter and beyond, Sahdev says. According to Rystad Energy, these balances are expected to be stagnant demand growth in the final quarter of the year, a decline in oil demand at refineries and a nearly 1 million bpd rise in non-OPEC+ supply.
“The fundamentals for 2025 do not provide a strong signal for a change in OPEC+ strategy,” Sahdev noted.
Tsvetana Paraskova for Oilprice.com
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