Morgan Stanley Says The Oil Squeeze Will End On August 17: Here's Why

Following his bearish note last week, Morgan Stanley's oil analyst Adam Longson is out with a new report, in which he accurately explains that the recent oil-price jump is driven by traders covering bearish bets, even as market fundamentals are seen remaining weak in coming months.

According to Longson, a “sizeable” amount of Sept. WTI put positions at $40, $45 recently came into or near the money, leading to spike in hedging by traders to cover their exposure. However, the good news for oil bears is that the effect of this action will fade once option expires Aug. 17. As we have pointed out previously, the recent comments from OPEC, and IEA helped reverse bearishness and also unleash the recent short squeeze which led to the biggest weekly jump in oil in 4 months.

He then notes that he “would not be surprised to see tank top fears return in 1Q17” as he sees rising U.S. crude inventories in coming months.

He list other bearish factors for oil, which include modest implied draw in global oil stockpiles in 3Q, as well as a lack of meaningful cuts to refinery run rates. A record OPEC production, albeit seasonal, with potentially higher Libyan exports and Iraqi output growth into 2017 add to bearish indicators.

He notes that the draw in U.S. gasoline inventory seen deceptive as higher net exports - lower imports and more overseas shipments - could be “masking the problem.” He concludes that if global product markets remain oversupplied, ability to export on larger scale may be limited and run cuts unavoidable.

This is what he said on the imminent end of the oil squeeze:

The Option Squeeze Lifts Oil Prices. Sentiment regarding oil continues to swing with price momentum, and in the short run, rapid shifts in positioning can move prices. A large option position and delta hedging left the market vulnerable to a rally. Thus, bullish comments from OPEC and the IEA caught the market uniquely offside to reverse bearish positioning (see detail and calcs inside). Yet, once option expiry passes on Aug 17th, this issue should fade. Moreover, this move higher also brought in bullish buying from those who believe the worst is past, and the call skew is now shifted bullish for Sep. The problem is that fundamentals tend to be a stronger driver medium term, and the picture appears skewed negative over the coming months.

Here are the details on what many believes is the key factor in the latest price spike, the short squeeze, and why Longson believes it will end in just two days.

As for fundamentals, nothing good here:

Finally, the biggest confusion emerges when looking at OPEC production, which despite a new bout of speculation about a production freeze next month, is producing at a record pace.

* * *

For now, however, the squeeze continues and oil has surged out of the gates, adding to its weekly gains, now up 16% off last week's lows, and almost back in a bull market.