Wall Street Journal: Many hedge funds are shifting from oil futures to shares of oil and gas companies
Speculators Shift Out of Futures, But They Find Other Ways to Bet; Is a Drop to Mid-$30s Coming?
Wall Street Journal, September 2
By Gregory Zuckerman and Thaddeus Herrick, Staff Reporters
Oil is dead. Long live oil.
Big investors have started easing back on some of their big bets in the oil market. But rather than leave crude completely behind, some are shifting to new energy investments -- like stocks of oil and gas companies -- convinced that energy prices will continue to stay high over the long haul, even if oil doesn't hit $50 a barrel soon.
For much of the past year, large investors, such as hedge funds and commodity-trading advisers, bought up oil-futures contracts and options, sensing a rise in oil prices. Speculators helped amplify the upward move, though the underlying combination of supply constraints and robust demand remains at the core of the high-oil-price thesis.
But in late August, the big financial players started getting skittish and began altering their energy bets. Some hedge funds, figuring that the market was getting ahead of itself, started bailing out of oil positions. Others began to ease off on energy investments when crude futures hit $48.70 on Aug. 19 but failed to breach the $50 barrier. Among the reasons for the retreat: a drop in crude demand as U.S. and European refineries prepare to shut down for scheduled maintenance and an easing of supply worries in Iraq, Venezuela and Russia.
The decline in oil prices, however, may be short-lived. Yesterday the price of oil surged on news from the Department of Energy's Energy Information Administration that U.S. commercial stocks of crude oil declined 4.2 million barrels from last week, leaving inventories near the lower end of the range for this time of year, and at the lowest levels since March 12. Gasoline and heating-oil inventories rose. On the New York Mercantile Exchange, U.S. benchmark crude for October delivery rose $1.88, or 4.5%, yesterday to settle at $44 a barrel.
Still, the number of oil-futures contracts held by noncommercial traders, which include hedge funds and similar investment vehicles, declined by 10% last week, according to the Commodity Futures Trading Commission. The Washington commission reported that 679,708 crude-oil futures were outstanding as of Aug. 24. Of those, 119,236 were for the purchase of oil, a decrease of 13,906 from the previous week.
"With political issues easing to some extent, speculators ... arguably have started to take money off the table," says Doug Leggate, an analyst at Citigroup who estimates that oil positions held by speculative investors fell 25% last week alone. He and other analysts say oil could head to the mid- or low-$30-a-barrel region, perhaps giving a shot in the arm to the economy and the overall stock market.
About 10 days ago, "many people were long, waiting for another push toward $50," says Jamie Philip, a senior commodity trader at Aspect Capital Ltd., a London-based hedge fund. When this didn't materialize, he says, these longs were forced out. That triggered the tumble in prices.
Mr. Philip says his firm, which had been holding oil futures and other bullish investments, substantially reduced its positions, as have other hedge funds. "It has been quite an orderly selloff," he says.
But few large investors are convinced that oil prices are heading below $35 over the long haul, due to constraints on global production and surging demand from countries like China. As a result, many hedge funds -- which are investment pools for institutions and the wealthy -- are shifting from oil futures and options to shares of oil and gas companies, traders say. These stocks usually move in sync with the price of oil, but most of these stocks haven't kept pace with the surge in oil prices in recent months and look cheap to many of these investors. If oil prices even stay near current levels during the next few years, cash flows will remain strong and the stocks will climb, they argue.
Oil remaining at current levels, however, is subject to much debate. "We're going lower, probably to the low to mid-$30s a barrel," says B.J. Willingham of Dallas-based hedge fund Moncrief Willingham Energy Advisers LP. But Mr. Willingham's firm believes that oil above $30 a barrel will still make energy shares a good bet. His firm has been buying select oil shares lately and is looking for more bargains.
As a result of the new buying, energy-related shares have surged -- even as the price of oil has tumbled. The OSX, the index of oil-service stocks traded on the Philadelphia Stock Exchange, has jumped more than 7.5% since Aug. 19, even as oil futures have fallen about 10% during the same period. Shares of major oil companies are up sharply since oil prices started their fall.
Transocean Inc., for example, a big drilling contractor that uses the stock symbol "RIG," has seen its shares jump to $31.26 from just above $28 a share since oil futures reached a peak on Aug. 19. ChevronTexaco Corp. has climbed to $98.67 from just above $93 on Aug. 24.
Meanwhile, many commodity-trading advisers have taken off bets that oil will hit $50 a barrel this summer, but they remain convinced that prices are going higher during the longer term. As a result, many are maintaining futures and options positions that will pay off if oil stays at relatively lofty levels, traders say. That is why futures prices for oil contracts in 2007 and 2008 remain around $35, and haven't fallen nearly as much as short-term futures contracts in recent days.
"The price of oil has fallen off since positive resolution of the insurrection in Najaf [in Iraq] and a subsequent diminution of the supply disruption premium," says Jason Schenker, an economist at Wachovia Bank. But world-wide demand "will drive the price of oil higher in the medium and long term."
Write to Gregory Zuckerman at gregory.zuckerman@wsj.com
and
Thaddeus Herrick at thaddeus.herrick@wsj.com |
