Many investors assume that the West Texas intermediate crude benchmark is the most important price to follow for North American energy, but in truth it's merely the most relevant of a number of spot prices. The real, market-moving action is in futures and the action has been fierce.
The first chart highlights the explosion of speculative interest in oil prices in recent weeks. The single line shown represents the combined long and short positions for non-commercial holders of oil futures contracts – the non-commercial interest metric is widely used as a proxy for hedge funds and other speculative investors.
Between September, 2010, and December, 2014, the average total long and short futures contracts averaged just less than 570,000 contracts. Since then, the average total (called "open interest" by futures traders) is 24 per cent higher at 706,000 contracts. The jump higher in oil futures trading has coincided with the most volatile few weeks of energy sector trading in recent memory.
The second chart compares the net non-commercial (hedge fund) positioning – total number of bullish, long contracts minus bearish, short contracts – compared with the U.S. oil spot price. A declining orange line indicates that hedge funds and futures markets are becoming more bearish – there are a rising number of short positions – and a climbing line suggests means more bets on a higher crude price.
There is not enough evidence here to definitively state that futures markets are driving the larger energy complex, even if I personally believe that's the case. Nonetheless, there are a few important trends evident in the chart. First, an increasingly bearish futures market (a falling line indicates more bearish bets) led crude prices lower beginning in June, 2014. Second, futures positioning since March of this year has been even more volatile than the commodity price itself. Speculators scrambled to cover short positions between March and May, leading a recovery in the oil price. From June, 2015, to mid-August, futures markets aggressively added short positions.
Importantly, the report on futures positioning is only available weekly from the Commodity Futures Trading Commission. In the chart, matching the futures data to the oil price means using weekly data for oil also and this masks an extraordinary amount of intra-week volatility in the commodity price, particularly in the past three weeks.
The fundamentals of the WTI spot price – how much oil produced and bought by refiners – don't change nearly as fast, or as far, as the commodity price has been moving. This is one of the main reasons I believe speculative futures traders – who can move at lightning speed – are currently driving volatility in energy markets.
The most current data show the net futures position near the lows for the year. For investors, this could represent a positive sign. It suggests that, while there are no guarantees in this volatile market, previous patterns suggest optimism in oil futures is likely to improve in the coming days.
Follow Scott Barlow on Twitter @SBarlow_ROB.