Oil selloff could have been worse after Doha failure

• Oil sold off on Doha disappointment, but selloff could have been steeper

• Rebalancing of the oil market is well under way, with US production falling

• Strike hits Kuwait production, lends some support to beleagured oil prices

• Prices could drop back to low $30s if Saudi Arabia fights Iran for market share

• Net long position reached new record last week, contango collapsed

• Watch $37.50/b on WTI and $40 Brent; break below could mean deeper downside

The oil markets reacted negatively today to the failed Doha meeting at the weekend. Some may ask why the selloff wasn’t any more severe considering that Opec once again showed a complete failure of leadership.

The rebalancing in the oil market is well under way, though it’s not Opec and Russia doing it, but rather North America where the production will continue to fall at such low oil prices. Some "support” came today from an oil workers' strike over pay in Kuwait, which has seen production fall 60% from its daily rate of 3 million barrels.

Crude oil, in my opinion, will remain range-bound for the next few months before rising as we move into the autumn. During this time, I see limited downside risk to oil beyond $35/barrel.

What could upset this equation is if Saudi Arabia turns its oil weapon on Iran. At the weekend the Saudis made threats which could indicate that they may choose to enter a market-share battle with Iran. If they decide to raise production to maintain market share, we could see the price drop back to the low $30s.

Hedge funds positioning, meanwhile, has turned even more extreme than we have seen already. Data published this afternoon on Brent crude oil speaks volumes.

The net-long position last Tuesday reached a new record above 400,000 barrels. The continued increase in bullish bets has tied in with the contango collapse in recent weeks, which has been taken as a sign of reduced oversupply. Most of this change has been at the very front of the oil curve and reflects lower supply in June and July due to maintenance in the North Sea. A lower contango reduces the pain of rolling long positions, hence the increased demand for Brent relative to WTI.

Another measure is the number of longs per short contract. As shown below, this ratio blew out to 12.3 last week. A reading this high is well and truly extreme, and it shows that the market is running out short positions to cushion a potential drop in the market.

A combined look at Brent and WTI show a near record net long of 608,000 contracts (608 million barrels), while the gross long has reached 766,000 contracts.

Oil is holding up relatively well today, but keep an eye on $37.50/b for WTI and $40/b for Brent crude. A break below this trendline and psychological level respectively could signal a deeper downside risk.