A near 10 % drop in international oil prices since the last month has taught a sore lesson to many hedge funds and other speculators in energy futures; that they can actually ignore physical markets for only a short period of time.

Hedge funds piled into what appeared to be a one-way bet earlier in the second quarter, seized oil contracts as the rapid advance of Islamist rebels in northern Iraq threatened supplies form OPEC’s second-biggest producer at the same time that climaxed summer demand was near term.

The arrival of purchases drove Brent crude oil to a nine-month peak above the $115 a barrel, but signs that the spike would be short-lived with the absence in plain sight according to several interviews with senior oil traders this week.

Although oil futures rallied, with hedge funds mounting up a record close to nearly 600 million barrels of oil on paper, real physical cargoes of crude oil were besieged as refiners are holding back from their purchases amidst the surprising unseasonable weak demand.

Once the refinery runs, it didn’t materialise due to the unplaced North Sea cargo which the market regard as a sign of apprehension and undue risk. A lot of people stopped out violently and volumes exploded which was the sharpest open interest decline in years which only confirmed the magnitude of the burden on the move down.

Tell tale signs

Between the weeks of June and the week prior at present, Brent prices cascaded from $115.71 to $104.39 a barrel, increasing losses for many investors. To experience market watchers the impending signs had to be made clear from the very beginning.

Just before the Iraq-led rally in futures, the prices for physical cargoes in the North sea diminished to multi-year lows with refiners declining to purchase as they grappled with frail margins for gasoline and diesel in Europe.

Another indication came from Urals, Russia’s primary main export in crude was experiencing a session of counter-seasonal weakness with the refiners actually losing more money on each barrel they processed for much of the month of June.

The weakness in the North Sea and Russia in combination with weak demand for oil from major West African producers Angola and Nigeria which have lost market shares in North America due to the shale oil expansion. Many cargoes were still left without direction on where to go.

Several analysts were experiencing tight this summer bit they were seemingly missing out on the increase in runs which were not happening in Europe but in Russia, the U.S. and Saudi Arabia, places with cheap feedstock.

This definitely tightened crude a bit but flooded the market with gasoline and diesel which crushed margins and slashing demand from European refineries.

Looking back at Contango

Hedge funds and several other traders were also betting that prices would in fact remain much stronger this summer than it did over a year ago due to an approach in market structure known as backwardation.

Heavy selling in the past two weeks which fast tracked Libya revealed that nearly a year-long port blockade was coming to an end which drove prices for delivery next month to a sharp discount to much alter contracts, more popularly regarded as contango. That ultimately changed market structure in many ways which have caught so many traders.

Last week, volumes in Brent leapt to a peak high with contracts equal to nearly 1.5 billion barrels of oil-more than two weeks of global demand that changed hands on just one session as traders adjusted to their respective spread positions.

Only 22 out of 24 analysts who predicted quarterly averages for Brent price in latest monthly poll by Reuters expected higher prices in the 3rd quarter than in the last three months of this fiscal year.

Only Portugal’s Banco BPI said that the prices would be slightly lower in the third quarter whereas ABN Amro speculated that they would remain flat within the $100 barrel range. Moreover, several other forecasters saw third-quarter price averaging more than $4 a barrel above those for the last quarter of this year.
Last week’s Brent prices had recuperated to just below $108 per barrel as the eerie events of the Malaysian commercial passenger jet was allegedly shot down over the skies of Ukraine intensified the stand-off between Western powers and Russia which further strengthened physical cargoes.