Risk Aversion Creeps Toward Oil Futures
By MATT CHAMBERS
August 13, 2007
Crude-oil futures are feeling the tremors emanating from the credit markets and are weakening on fears that they could be the next casualty of the risk exodus.
When markets began to gyrate two weeks ago, traders and analysts assumed that oil markets would only be indirectly affected: The lack of information on losses from the subprime crisis could spread to the broader economy, cutting energy demand.
Now, however, some say oil futures could be hit head on. The flight to cash could force hedge funds to dump commodities futures as they reduce risk. It's these hedge funds and other speculators that recently have helped drive crude to records.
"If liquidity dries up, or slows down [in credit markets] and speculative interest that has supported energy markets dissipates, there is real downside risk for crude," says Jason Schenker, an economist at Wachovia Corp. in Charlotte, N.C. "There is no upside to oil prices at all in this credit risk."
Light, sweet crude on the New York Mercantile Exchange has slumped 9% from its intraday record of $78.77 a barrel, set Aug. 1, partly spurred by fears that funds -- still thought to be holding a large net-long position, or bets on a price gain -- might add fuel to any price fall by rushing for the exits.
While funds have likely discarded more positions since then, the fact that Goldman Sachs Group Inc. and other hedge funds are liquidating various investments to curb risk is creating edginess over the potential for more fund selling.
While evidence of an economic slowdown is yet to be seen, "what is not in doubt is that investors are raising cash and that could weigh heavily on energy prices as speculative interests turn defensive," says Mike Fitzpatrick, vice president of energy risk management at MF Global in New York.
Hedge funds began liquidating their record number of bets in the week ended Aug. 7, according to U.S. government data released late Friday. The net number of long positions in Nymex crude futures fell 17% to 106,258 in the week ended Aug. 7, from a record 127,941 the previous week.
Despite the drop, the long position is still historically high.
"I think that crude oil remains a rather heavily overbought market," says Tim Evans, an energy analyst at Citigroup in New York. "Now we have a flow of selling established. They've stopped buying and have started liquidating."
Apart from the possibility of funds selling off, uncertainty over whether the subprime crisis will spread to business borrowing and crimp economic growth continues to spook crude markets. |
