A Historic Short Squeeze In Oil Has Only Begun

Goldman Sachs Predicts Massive Short Squeeze in Energy Stocks

Last weekend, it was brought to the attention of readers that, based on the latest data from Goldman Sachs, a significant short squeeze in energy stocks was impending. It was noted that at a time when funds were the most short oil on record, the broader energy space was the most net sold sector on the Goldman US Prime book. This was driven entirely by short sales, which outpaced long buys (6.4 to 1). It was suggested that this was a hint to the next mega squeeze, as the recent short selling in energy was the largest in over 5 years.

Brent Crude Soars in Historic Short Squeeze

What transpired next was historic, as Brent crude soared the most in almost two years on the back of what was a historic short squeeze. Some media outlets mocked those who traded ahead of the inevitable squeeze as "tourists", when in reality the only tourists here are those who expected the ridiculous plunge in oil prices to persist despite Cushing approaching tank bottoms.

Squeeze in Energy Just Getting Started

However, the squeeze in energy is just getting started, and not just due to fundamentals. Crude oil soared last week as a result of the rapidly deteriorating situation in the middle east. The energy complex jumped again on news that the US was considering whether or not to support Israel’s potential retaliatory attacks against Iranian energy infrastructure.

Goldman Sachs' Calculations on Impact of Israel Limiting Iran Oil Output

Over the weekend, Goldman Sachs' commodity analysts published a new report in which they tried to calculate the impact on the price of oil should Iran oil output be "limited" by Israel. They estimated that Brent could temporarily rise to a peak of $90 if OPEC rapidly offsets the shortfall, and a 2025 peak in the mid $90s without an OPEC offset.

Goldman's Prime Brokerage Notes Increased Short Covers

Furthermore, Goldman's Prime Brokerage noted that after heightened geopolitical tensions and rising crude oil price, hedge funds reversed course and net bought US Energy stocks for the first time in 7 weeks, driven almost entirely by short covers. As a result, the US Energy long/short ratio increased +5% – the largest weekly increase in nearly 5 months – to 1.36.

Short Overhang in Energy Remains Staggering

However, the short overhang in energy remains staggering, and hints at a far more brutal unwind once the upward momentum persists for another week. This is not only in energy stocks where the short flow on Goldman's Prime Brokerage is just shy of record highs, but also in the oil patch. After oil short interest hit a record two weeks ago as traders turned the most bearish on oil they have ever been, the amount of short covering was virtually non existent.

Goldman Energy Specialist's Take on the Situation

Goldman Energy specialist Ryan Novak stated that "energy led to the upside on the week after we exited the prior week with aggressive PB selling/short selling that flipped this week, managed money positioning remains short - at all-time lows and tensions across the Middle East escalating with Israel beginning its ground invasion. E&Ps led on the week +7%. All eyes on any incremental news regarding any attack on Iranian energy infrastructure which would pose further upside risk to the commodity and equities."

Bottom Line

With record shorts now painfully squeezed as upward momentum has been ignited across the energy sector, and the risk of a flashing red headline that Israel has leveled Kharg Island looming, unwind of what until a week ago was a record short position in oil and energy stocks is just getting started. And that's without Israel even doing anything. Should Israel however take the plunge and either take out Iran's oil infrastructure or, worse, target its nuclear industry, then the coming explosion in oil will make the Volkswagen short squeeze of 2008 seem like quaint amateur hour. What are your thoughts on this development in the energy sector? Do you think the short squeeze has only just begun? Share this article with your friends and discuss. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.