Temptation grows for arbitrageurs on forward oil.
By Toby Reynolds 778 words 17 March 2005 06:45 am Reuters NewsServiceLine
(c) 2005 Reuters Limited
LONDON, March 17 (Reuters) - The reluctance of oil companies to lock in record forward oil prices has attracted arbitrageurs to a play that could stall an unprecedented bull run further along the crude price curve, a leading analyst has said.
Producing companies have declined to take advantage of forward oil prices that now offer more than $48 per barrel all the way to 2010, puzzling analysts, who note that oil majors have held planning assumptions some $25 below that.
Reluctance to sell long dated futures has fuelled a record-breaking rally over the last two years as institutional investors, noting bullish forecasts for growing demand and supply constraints, have bought heavily into energy.
Now the speculators have bid up the price of future oil supplies so much that private investors are starting to see value in selling forward even though big oil firms do not.
Oil economist Phillip Verleger has noted the efforts of billionaire financier Carl Icahn to persuade U.S. independent firm Kerr-McGee (KMG.N) to use record forward prices in an arbitrage against the relatively discounted value of the company's stock.
Kerr-McGee's management has rejected the proposal. But Verleger suggests that such a trading strategy could yet provide sellers to cool the unprecedented rally in long-dated oil futures. "The battle between the longs and the shorts over the oil price trend would begin in earnest if Icahn succeeds in persuading Kerr-McGee," Verleger wrote in a weekly research note. "If he does, that would create a large supply of oil to match demand coming from retirement funds. In case you missed it, the absence of such sellers has helped propel spot prices higher."
UNWILLING SELLERS
"A great opportunity exists today for stockholders of Kerr - McGee," Icahn and venture partner Barry Rosenstein wrote in a March 3 letter to Kerr-McGee management, filed with regulators.
"Never before has there been such a disconnect between the stock market valuation of publicly traded exploration and production companies such as Kerr-McGee on a per barrel of oil equivalent of proved reserves basis and the value at which oil and gas futures are trading in the commodity markets."
So far oil firms have shown little interest in selling forward, except as part of project financing obligations. Kerr-McGee's board rejected the forward sale proposal, saying it would not leave sufficient capital to develop existing proved reserves and discover new ones.
Majors, as a rule, do not hedge at all except if required to under project financing deals, traders say. Some small firms do hedge their production a little, but volumes tend to be low.
Analysts say one conventional ex planation for this reluctance to play the forward curve is that liquidity is too low, and that any significant selling could bring prices crashing.
Another suggestion is that equity markets would look unfavourably upon such a move. Some investors want a correlation between an oil firm's stock price and the underlying crude market.
More simply, executives might see the equity market as more forgiving of missed opportunities than bad, under the-market hedges - perhaps implying that the directors of majors like BP (BP.L) and Exxon Mobil (XOM.N), who have said oil prices will fall, see some risk that they might be wrong.
Canadian producer Husky Energy (HSE.TO) reported lower upstream earning in the fourth quarter of 2004 compared to a year before partly due to hedging losses.
MISSED OPPORTUNITIES?
In a late January note announcing Pioneer Natural Resources (PXD.N) had sold forward 10.8 million barrels of oil equivalent over seven years from 2006, Chief Executive Scott Sheffield pointed out his firm had received eight percent of its enterprise value from selling only two percent of its reserves.
"Collecting the value of these reserves today...gives us the flexibility to capture the arbitrage opportunity presented by the equity market's failure to appropriately value companies with longer lived reserves," Sheffield said in Pioneer's January 27 statement.
That Pioneer sale moved just over 4,200 barrels per day onto the longer dated oil market. Icahn's plan for Kerr-McGee, outlined in March 10 regulatory filings, would involve much more: about 50 million barrels equivalent per year over five
years, or 137,000 bpd.
"Whether Icahn will succeed in his effort cannot be known at this time. Furthermore, one cannot judge whether such sales would quench the thirst of pension funds and other buyers for collateralized futures," wrote Verleger. "All one can say is that a potential threat has emerged to what has been a one-way up escalator." |
