Why the oil rally is losing momentum

The rally that carried oil prices up by more than $20 per barrel between the middle of January and the end of April seems to have run out of steam for the time being.

Spot crude prices, time spreads and refining margins have all showed signs of weakening since the start of this month. Crude prices are struggling to rise further despite signs of continued growth in consumption.

Prices for both WTI and Brent futures with delivery dates in July peaked at the end of April and have been gradually falling.

Prices for both futures contracts closed below their 14-day and 20-day moving averages for the first time last week since early April illustrating how the rally has run out of momentum.

Timespreads, which tend to track the supply-demand balance, have eased since the end of April after tightening progressively since the start of the year.

Short-term interruptions to crude output, ranging from the wildfires in Alberta to problems with Libya’s exports, have failed to provide a sustained boost to either spot prices or timespreads.

Refining margins have also started to soften which could be a bad sign for oil demand if they encourage refiners to cut crude processing.

In the United States, the generic 3-2-1 crack spread, which measures the gross revenue from turning three barrels of crude into two barrels of gasoline and one barrel of diesel, has fallen from $19 to around $15.50.

Valero, the largest independent refiner in the United States, reports indicative margins for its refineries along the Gulf Coast have dropped from $20 to less than $17.

After firming progressively since February, indicative margins for refineries in the mid-continent area slipped last week from almost $13 to less than $11.

In the last couple of weeks, U.S. refinery throughput has slipped below the record rates reported at the same time a year ago.

Hedge funds seem to sense the rally may be running out of momentum, and have closed some bullish long positions, taking profits.

Hedge funds and other money managers reduced their record net long position in WTI and Brent futures and options from 663 million barrels on April 26 to 620 million barrels on May 3.

Long positions were cut by almost 38 million barrels while short positions were increased by more than 5 million barrels.

Profit taking was especially pronounced in Brent, where hedge funds and other money managers cut their long positions by 28 million barrels, or around 6 per cent.

Across the three major WTI and Brent contracts, hedge funds cut their net long position by 43 million barrels, the largest one-week decline since November 2015.

The concentration of hedge fund positions on the long side of the market has increased the risk of a price reversal as a result of long liquidation.

The oil market is heading into the strongest period of demand in the year as the U.S. driving season begins at the end of the month which should provide some support to prices.

But at the moment attention has shifted away from the decline in crude production and growth in demand to the overhang of refined products such as gasoline and diesel, causing the rally to stall.