The best macro trade of 2017
What has been the world’s most crowded macro trade of the year to date? No, it has not been buying dollars, shorting US bonds or selling French OATs or sterling, at least relative to the size of these huge markets. The most over-extended speculative position in the world by historic standards has been the bullish exposure to crude oil. This speculation began to reverse last week, and the -7% correction in Brent could soon turn into an avalanche.
The first chart speaks for itself. Net long positions peaked on February 21 at the highest level on record, 20% higher than their previous record in June 2014, just before the start of the oil price collapse from $115 per barrel to $38. This wild speculation has occurred against a background of recordbreaking inventory levels, rapidly rising US shale production and a collapse of long-term futures prices to the point where a barrel of oil for delivery in 2020, which was priced in November at a $10 contango premium to the spot price, is now trading at a discount.
There is an obvious explanation both for the record level of speculative buying and for its failure to drive the price of oil significantly higher. Traders have overestimated the importance of OPEC as a driving force in the oil market, a blunder which the markets keep on making every time a Middle Eastern oil minister opens his mouth.
As I have argued repeatedly since late 2014, the OPEC oligopoly has been decisively broken by a combination of supply- and demand-side factors — the shale revolution and the impact on long-term demand of clean energy technologies and regulations. As a result, oil now trades just like any other commodity, such as copper, pork bellies or iron ore.
Even if the Saudi, Russian and Iranian governments can continue to reach production restraint agreements, these will have no more lasting success in driving up the oil price than would similar agreements between Rio Tinto, BHP Billiton and Vale on boosting the price of iron ore. (Incidentally, all of OPEC plus Russia only control about 50% of global oil supplies, compared with a market share of around 70% for the top three iron ore producers.)
The fact is that far more oil has already been discovered than the world will ever burn, as BP has now explicitly predicted.
The managements of Exxon and Shell have implicitly conceded this by cutting back on exploration, selling off oil producing assets and abandoning the obsession with reserve replacement, which used to be considered a symbol of success for oil producers. And now the Trump administration appears intent on aggravating long-term over-supply of fossil fuels even more by further deregulating US oil and gas development and even by subsidising coal.
The upshot of all these influences is that the model of oil price regimes that we proposed in late 2014 seems to be working: $50/bbl or thereabouts for WTI, which is the marginal cost of shale production, has been confirmed again as a long-term ceiling — and the next major move will almost certainly be a big fall in the oil price, the exact
opposite of what so many speculators seem to expect.