The latest CFTC data shows that the net long non-commercial WTI NYMEX position has declined by 1,288K barrels w/w. This decline is due to long positions declining by 11,016 contracts, while shorts dropped 9,728 contracts.

However, speculative interest in the crude oil market remains high despite the recent sell-off. The net speculative position as a percentage of open interest registered 10.1% last week. This is marginally lower than the previous week?s 10.4%. However, the latest CFTC data captures the speculative positions up to Tuesday last week, and the data doesn?t reflect the sell-off in commodity prices since Wednesday last week. While we believe the majority of weak long positions have liquidated, the crude market still has weak underlying fundamentals. US refineries are cutting back on utilization levels (currently at a low 78.4%) but refined product inventory levels remain very high (with gasoline inventories showing a sharp rise last week
despite declining refinery activity).

OPEC production continues to rise, in defiance of their official quota (of 24.845m barrels per day) and despite the large overhang of crude inventory. OPEC produced 28.9m barrels per day in December ? up from 28.9m in November last year. Despite the excess crude supply, we believe oil demand will continue to grow this year; we believe the market will slowly normalise in 2010 and 2011. A market in recovery is volatile, and volatility should therefore remain a key feature for oil this year.

While the US dollar is important, we prefer to look at the equity market for direction in the crude oil market right now. Since November US equities have had a higher correlation with WTI front-month prices than the dollar. Stabilisation of equity prices should signal support for crude oil returning. After three days of heavy selling in the equity market on the back of regulatory concerns, rather than very weak economic data in the US, this could indicate imminent support. Higher equity prices should also coincide with a decline in the VIX index (which measures volatility of the S&P index). This signals the return of healthier risk appetite.