Before the attacks on Saudi Arabia's oil installations on Sept. 14, hedge fund managers had started to become more bullish, or at least less bearish, about the prospects for oil prices amid hope for a trade truce between the United States and China.

Hedge funds and other money managers purchased the equivalent of 122 million barrels of crude and fuels in the six most important futures and options contracts in the week to Sept. 10, the largest one-week increase for more than a year.

The jump came after five months in which fund managers had been mostly sold oil, suggesting the market had reached a turning point even before the attack on Abqaiq.

Portfolio managers were buyers of Brent (+52 MMbbl), NYMEX and ICE WTI (+30 MMbbl), U.S. gasoline (+9 MMbbl), U.S. diesel (+9 MMbbl) and European gasoil (+21 MMbbl).

Position changes were split fairly evenly between short-covering and the establishment of new long positions, according to an analysis of records published by regulators and exchanges.

Fund managers cut short positions by 54 MMbbl while boosting longs by 67 MMbb.

The ratio of hedge funds' long to short positions, probably the most useful way of measuring their expectation of future price changes, jumped to 4.00:1 from 2.91:1 the previous week.

Most of the bullishness seems to have come from increased hopes the United States and China would reach at least a temporary truce in their worsening trade conflict.

Both governments announced confidence-building measures, including the postponement of some scheduled tariff increases, ahead of a planned resumption of trade talks in October.

New Situation
The attack on Saudi Arabia's oil processing facilities at Abqaiq and its Khurais super-giant oilfield has completely transformed the market situation.

By removing more than 5 MMbl/d of crude production from the market, some of it for an extended period, the attacks amount to a significant negative supply shock.

Front-month Brent futures prices surged by more than 14% on Monday, equivalent to more than 6.6 standard deviations, and the largest one-day percentage increase on record.

The extended production shortfall will have to be met from a combination of commercial inventory drawdowns, releases from government-controlled emergency stocks, and price-driven demand restraint.

Substantial price increases signal the need for consumers to use less fuel until the facilities can be repaired or alternative production becomes available.

Hedge funds are likely to have been substantial buyers of crude contracts on Monday, which will accelerate and possibly exaggerate the adjustment process.

Growth in oil consumption, which was already well below its long-term trend in the first half of the year, is now likely to remain weak through the end of the year.

The outlook over the next 6 to 12 months is complicated.

On the production side, damage to Saudi installations will cut output and points unambiguously to the need for higher prices to rebalance the market.

On the consumption side, a trade truce would be positive for fuel use, but higher prices will hit a global economy that has already lost significant momentum, cancelling some of the benefit from trade, and could cut consumption significantly.

Oil prices will have to be higher than they would have been without the attack on Abqaiq. But how much higher depends on how long it takes to make repairs; whether policymakers choose to release emergency stocks to blunt the price impact; and how higher prices interact with an already slowing global economy.