TD Securities: Will Oil Rebound Follow Peak Algo Selling?

TD Securities has offered an interesting perspective on the current state of the crude oil market, suggesting a potential near-term bounce in oil prices. While algorithmic selling has dominated recent market movements, there are signs that this trend could be reversing.

However, TD also highlights several underlying risks that suggest any recovery may face significant headwinds.

Algorithmic Selling Reaches a Peak

TD Securities' analysis centers around the activity of Commodity Trading Advisors (CTAs), who use algorithmic trading strategies to navigate the crude oil market. According to TD, these trend-following algorithms have been a significant force behind the recent downturn in oil prices.

The note points out that a recent sell-off accounted for a 6% reduction in the maximum position size held by these CTAs, marking what appears to be the peak of algorithmic selling for now. This observation indicates that the worst of the selling pressure may be over, providing room for a potential rebound in prices.

In a positive turn, TD suggests that CTAs are expected to switch to buying both West Texas Intermediate (WTI) and Brent crude under all scenarios in the coming week, even if there is a significant decline.

This shift from selling to buying by a key segment of market participants could provide a tailwind for oil prices, potentially reversing the recent downward trend.

Structural Issues Loom Over Potential Recovery

While the anticipated change in CTA positioning is a positive sign for the crude oil market, TD Securities cautions that deeper structural issues remain. The primary concern is that the risk premium on energy supply is falling sharply.

This decline is driven by fears that OPEC+ could increase production, coupled with optimism surrounding a potential deal that could see Libyan oil exports return to the market. Such a development would increase global supply, thereby putting further downward pressure on prices.

Additionally, the sentiment around commodity demand is weakening. A major point of concern is the reduced demand outlook from China, the world's largest oil importer.

The market is grappling with worries that economic challenges in China, including sluggish growth and possible refinery cutbacks, could lead to decreased oil consumption. Lower demand from China would weigh heavily on global oil prices, exacerbating the impact of any increase in supply from OPEC+ or Libya.

The Role of OPEC+ and Future Risks

The ongoing situation puts pressure on OPEC+ to reconsider its planned production increases. Should the group proceed with increasing supply, it could further erode the risk premium on energy, leading to additional declines in crude prices.

TD's note implies that a decision by OPEC+ to postpone production increases could help stabilize prices and maintain some level of support in the market.

Despite the potential for a short-term rebound driven by CTA activity, TD Securities emphasizes that risks remain tilted to the downside.

The current weakness in crude prices cannot be solely attributed to algorithmic flows, as fundamental issues such as supply risks and weakening demand play a more critical role. Traders and investors must consider these factors when evaluating the oil market's future trajectory.

Conclusion

TD Securities provides a cautiously optimistic view on the potential for a short-term bounce in crude oil prices, driven by a shift in CTA positioning.

However, the deeper concerns related to supply risks, particularly from OPEC+ actions and Libyan oil returning to the market, combined with weakening demand sentiment from China, suggest that any recovery may be fragile.

The interplay of these factors will be critical in determining the next phase for crude oil prices. For investors, the takeaway is clear: while a bounce is possible, the road ahead is fraught with uncertainty and potential volatility.