Wave of Bullish Oil Bets Drives Big Price Moves

The upbeat sentiment has made oil one of the hottest trades on Wall Street, briefly pushing U.S. crude prices earlier this month above $75 a barrel and to the highest closing level since late 2018. Prices have roughly doubled since the end of October. 

But investors crowding into the market are also fueling concerns that oil has risen too quickly, a force that can cause market turbulence. The CFTC data measure futures and options, which are commonly used by professional investors to wager on oil-price movements and by energy producers to hedge against volatility. 

Last week, prices briefly hit their highest point in more than six years on July 6 before ending the day down more than 2%. The volatility continued, with oil frequently changing directions before surging Friday and ending the week down slightly at about $74.50 a barrel.  Prices slipped again Monday, to $74.10 a barrel, which is still the fourth highest settle value this year. 

One reason investors cited for sharp reversals in a matter of minutes during trading sessions was the bullish positioning. With so many analysts anticipating further gains, the slightest bit of bad news can prompt traders to unwind some of their holdings. 

As investors weigh uncertainty about future supply levels from the Organization of the Petroleum Exporting Countries and allies including Russia, some say conditions are ripe for more price gyrations. The division within OPEC comes as the United Arab Emirates pushes to produce more crude, prompting the cancellation of a recent meeting. The threat of new coronavirus variants slowing the global economy and hitting demand could also halt the recent rally, some analysts say. 

Even though many investors still predict that prices will find support as more consumers travel and producers limit new supply, some are bracing for oil’s wild ride to continue. 

“When everyone gets overly bullish, it’s time to start thinking about what the downside risks are,” said Rebecca Babin, senior energy trader at CIBC Private Wealth Management. 

Many Americans are closely watching energy markets because higher oil prices translate to elevated gasoline prices at the pump, squeezing consumers, who are already facing rising prices for many products. This year’s gasoline-price surge has even contributed to some investors’ anxiety about a murky inflation picture and possible interest-rate increases. 

As demand surges alongside Covid-19 vaccination rates in the U.S. and other developed economies, some traders in recent months have been using options—which give the holder the right to buy or sell an asset at a specific price in the future—to bet on U.S. crude soaring to $100 a barrel by the end of next year. 

Many analysts worry about a large buildup of such bullish wagers because a sudden reversal and wave of selling can spread financial pain across Wall Street, potentially dealing a blow to investors and even the economy if many traders are forced to sell unrelated assets to cover losses. 

In another example of how one-sided positions can drive market swings, the yield on the 10-year Treasury note has retreated to around 1.35% from its March peak of 1.75%, wrong-footing many speculators who had positioned for longer-term government-bond yields to climb. Yields fall as bond prices rise. The decline has followed some mixed economic data points and signals that the Federal Reserve plans to gradually pare back its easy-money policies, prompting bets on slower growth. 

Still, few expect an extreme drop in crude prices. Under pressure from investors to limit spending and emissions, U.S. shale producers have recently held supply lower than some analysts expected in a rising price environment. 

Some investors also anticipate that Wall Street’s focus on limiting new fossil-fuel spending to fight climate change will starve companies such as

Devon Energy Corp.

and

Pioneer Natural Resources Corp.

of new project funding, limiting their production in the years ahead.

Even though OPEC recently failed to come to an agreement about future output figures, the group has so far remained cautious about flooding the market. As a result, many investors are looking past near-term swings and sticking with optimistic forecasts. 

“The oil market has been on a one-way ripper since November,” said

Bob Yawger,

executive director of energy futures at Mizuho Securities. “We could go a lot higher.”

Shares of many energy companies are still up 40% or more for the year, despite some recent turbulence, and 18 large exchange-traded funds that track the sector recorded their biggest one-day combined inflow on June 22 in data going back to April 2019, according to Dow Jones Market Data. That day’s inflow for the Energy Select SPDR Fund was the highest in more than five years. 

Some investors have also been buying energy bonds that offer higher yields because ultrasafe assets such as cash and government debt currently offer muted returns. The extra yield, or spread, over U.S. Treasurys that investors demand to hold speculative-grade bonds of energy firms recently hit its lowest level in 3½ years, according to Bloomberg Barclays data.

While many large investment firms are paring back their energy investments for climate-focused reasons, the trends indicate that some on Wall Street are still willing to chase profits in the sector. 

“I think overall energy sentiment is going to continue to be positive,” said Noah Barrett, research analyst at Janus Henderson Investors.

—Sam Goldfarb contributed to this article.