Oil & The China Syndrome
Checkmate in Chinese Revisited
When it comes to oil, I admit that I have more questions than answers today. Chalk it up to my feeble attempts to keep an open mind while I dream up the most absurd potential outcomes as the most likely ones. We must always respect Shrub’s Razor:
Shrub’s Razor is a philosophical trading principle whereby the funniest, most absurd outcome is also the most likely one.
As some readers may recall in my comments on the chat, what started as a general uneasy feeling of a ‘lack of control’ back in April when equity risk was starting to rip and oil failed to maintain momentum was, with the benefit of hindsight, a sense of seeing a bullish consensus among experienced commodity players (I’d like to think of myself as one of them, but I don’t know anymore) in a firm consensus that the market had stopped confirming. Something else was going on, and that was a classic “Kovner signal” to get out of the way.
“What I am really looking for is a consensus the market is not confirming. I like to know that there are a lot of people who are going to be wrong.” — Bruce Kovner
Of course, this sense is how many drawdowns begin, and in not listening to it, I took a nice dose. At least now I think I understand the two key visible factors I got wrong in being bullish oil into the recent collapse.
What were the two factors?
First, beyond the visible SPR and commercial inventory draws in crude and products which we have discussed for months, China stepped out of the global market beginning in April to the tune of >4mmbpd which significantly loosened the physical market. I will come back on China after addressing the second factor, as China is at the heart of my questions.
Side note for younger readers: the title of this note harkens back another crazy time in the oil market (1970s) and refers to a theoretical nuclear meltdown scenario where a reactor’s core becomes so hot it melts through its containment structures and tunnels straight through the Earth, conceptually “all the way to China.” The China Syndrome was immortalized by the thus-named 1979 disaster thriller featuring a television news reporter (played by Jane Fonda) and her cameraman (Michael Douglas) who accidentally film an emergency shutdown at a nuclear power plant. They soon uncover systemic corporate cover-ups and corner-cutting, while a dedicated plant supervisor (Jack Lemmon) desperately tries to expose the dangers of a potential meltdown.
The second factor was that speculators took that physical cue and swung from one of their largest net long positions to one of their lowest exposures in the span of a few weeks:
Looking at the chart above, the horizontal orange line shows you the current Brent + WTI (Nymex + ICE) combined managed money net long position in notional US$ (red line series), which you can see has rarely been this washed out. In fact, the current level of positioning marked significant near-term lows over the past two decades, exceeded on the downside by the 2015 shale implosion, the sudden 2018 surplus, April 2020 Covid collapse, mid-2024, and 4Q25 (when the consensus was for a 3mmbpd Superglut in 2026). I am probably not the first to think this, but it’s worth saying: if you told me a few months ago that speculators’ bullishness and positioning would be swinging extremes like this in the teeth of ~5-7mmbpd global inventory draws, I would have said you probably need to talk to someone. As it turns out, I’m the one who is crazy and has been wrong. Welcome to the Upside Down.
For more context on just how wild positioning is, John Kemp at Reuters noted this weekend that WTI and Brent net positions are down to the 11th percentile going back to 2011 (see fourth column)…
…while the long/short ratio for Brent is now down to the 2nd percentile (right column above):
In WTI crude, the non-commercial (speculative) net long position in futures & options as a percent of open interest is actually at levels below the shale blowups of late 2015, and even lower than the troughs seen in 2023-24. Only 2025 saw lower levels than this, back to 2012.
I discussed positioning in more detail two weeks ago when Brent was just below $90, so I won’t rehash the full case further. As a corollary to sentiment though, around the same time I started a thread of oil bears dunking on experienced oil observers and barrel counters (I suppose because the bulls are deluded in thinking inventories matter to price as they always have throughout history, so this time is different). The thread got some attention after my pal Kevin Muir cited it in his excellent bullish energy note two weeks ago which I definitely encourage you to read (and subscribe to him as he is excellent; the link above should get you past the paywall to the note). To be clear, I began this thread because of a phenomenon I call The Pile On which is why, in breaking some trading rules (that clearly exist for good reason), I have actually upped my exposure again over the last two weeks of decline. The issue more fundamentally is that this bearish jubilation reflects a Soros Misconception that stems from a lesson I spend a lot of time trying to teach my kids when getting them to do their homework:
Good process → Good outcome = Deserved success
Good process → Bad outcome = Tough beat
Bad process → Good outcome = Lucky break
Bad process → Bad outcome = Just desserts
Don’t get me wrong: I will gladly take a lucky break over a tough beat…better lucky than smart, I say. Although sticking with fundamentals tends to tilt outcomes into “deserved” vs “just desserts” over time, tough beats do happen, and they are incredibly frustrating when you are playing with real money. Yet the dunking really doesn’t bother me, because I know its foundation is in Bad Process → Good Outcome. This may sound like cope in a drawdown, but saying things like “there’s plenty of oil around” while suspending laws of physics governing volume and time is not rational. Saying that oil is pricing the present inventory when it’s at $100, but then “let’s price the future superglut at $70” is inherently inconsistent, and a narrative solving for price. And predicting a swing in positioning the likes we have not seen outside of 2018 or the 2008 GFC is… well… I tip my hat tip to those who may have called that in the midst of the tightest oil and product market in history because that is one helluva crystal ball. Sadly I do not have one, so I am left with Risk vs Reward.
My priors notwithstanding, I believe it is possible that a bear trap is being set with current positioning, but for the trap to spring, the physical market needs to tighten. If a loosening near-term physical market swung positioning down, it stands to reason that speculators will have a very hard time shorting or remaining underexposed a physical market that tightens again out of nowhere (though at this point anything truly seems possible). For that, I come back to factor #1 cited at the top: we need to see what China will do. Keep in mind, even despite China’s absence, the world is still drawing >35mm barrels per week since this crisis started, with Kpler citing a -49mmbbls drawn last week (this is crazy). Still, if China were to reemerge as a buyer, the physical market would significantly tighten almost immediately.