Why shorts on oil stocks have soared to multi-decade highs
Traders are betting big on an oil price collapse just months after brent crude surged to an all-time-high following the break out of conflict in Ukraine.
Data from Clocktower shows puts against oil stocks have exploded in recent weeks. The elevated put volume suggests the oil price could fall harder than it did during the 2008 Financial Crisis and the 2014 oil price shock if trends repeat.
Some traders may have already cashed-in this week. On Wednesday, brent crude fell to a six month low.
However, Clocktower thinks the collapse could only just be getting started.
And it’s not U.S. recession fears that has the California-based investment strategists bearish on the oil price. They say traders and investors in oil stocks should be looking closely at China and the Ukraine.
Slowing China demand (not) weighing on the oil price
China is currently the second-largest consumer of oil, after the United States, and many have predicted China will overtake the U.S. as the world’s largest oil consumer by 2040.
But the Chinese economy has been slowing and Clocktower thinks it’ll be more than a short term problem.
“Chinese demand should drag oil prices lower, with no sign that long term demand is about to de-trend from the recent flattening. The collapse in Chinese imports is not merely a function of Beijing’s zero COVID-19 policy. Rather, it is a mix of both COVID-19 lockdowns and a lack-luster economy, which policymakers appear to be hesitating to revive with gusto. Effectively, Beijing is pushing on a string, with the private sector now over-leveraged following a decade-long credit binge.”
So why has oil soared in 2022 against the slowing China narrative?
The answer lies in Eastern Europe.
The China gap
In the chart below you can see a divergence between Chinese oil imports and the oil price. This is a phenomenon without precedent in recent decades.
Clocktower says the reason this is occurring is a “geopolitical risk premium” that’s been caused by the conflict in Ukraine.
“Given that both Chinese demand and the US economy/inflation are downshifting (Chart 3) – which ought to be negative for oil prices – the diagnosticity of elevated geopolitical risks in Ukraine are rising. Put simply, the median investor is hanging their oil bullish hat firmly on the hook of geopolitical risk.”
So, if the thesis of oil bulls comes down to an extended conflict in the Ukraine, does the massive increase in oil puts suggest the new consensus is that the war will soon end?
“Our suspicion is that, given the costs of continuing operations in Ukraine, Moscow has an incentive to declare victory once Donbas is conquered,” says Clocktower, noting that there may be no real obvious ‘end’ to the war.
“The Korean War has been such a ‘frozen’ conflict for 69 years, but it never officially ended… if the conflict in Ukraine settles into a frozen conflict over Donbas, we suspect that the political path of least resistance for most European policymakers will be to tone down the implementation of energy boycotts given the rising cost of energy.”