Follow-up to my previous post...
The media-shy masterminds of the Russian bailout:
Speculation puts pressure on oil prices
Crude reaches $44.34, a record, before falling
By Heather Timmons
NEW YORK TIMES NEWS SERVICE
August 5, 2004
LONDON – Oil prices touched another record high yesterday, and then fell by more than $1 a barrel, as turbulent markets reacted to new promises of greater production.
The energy markets have become more volatile in recent months, traders and analysts say, as speculators and large institutional investors, frustrated by the lackluster equity and bond markets, turn to oil in search of richer returns. Their activity is helping to move crude prices faster and farther than market fundamentals would seem to warrant, and not always in the expected direction.
Yesterday, the most widely followed barometer of the market, low-sulfur crude oil for delivery next month, briefly traded as high as $44.34 a barrel, then swiftly plunged to $43.99 at the close of floor trading on the New York Mercantile Exchange. By the end of the day, the contract had settled at $42.83 a barrel.
Two new developments helped relieve upward pressure on prices. The Energy Department released figures showing that gasoline inventories had grown by 2.4 million barrels, to 210.1 million. Separately, Saudi Arabia said it would start pumping crude oil from new fields three months ahead of schedule and delay the closing of some old wells.
But traders said it is anybody's guess as to which way prices may be headed next. "In this environment, even seasoned professionals find themselves scratching their heads," said Jay M. Levine, an institutional energy broker with Advest Group based in Portsmouth, N.H.
Both the unpredictability of price movements and the unexpectedly rapid 35 percent run-up in oil prices this year can be traced in part to major growth in trading activity in the oil markets. According to the most recent available figures from the Commodity Futures Trading Commission, the total value of open interests in crude oil-based futures and option contracts traded on the New York Mercantile Exchange grew by 32.7 percent, or $26.6 billion, over the 12 months ended in mid-June.
"Speculators don't set the price, but they intensify a price movement in either direction, beyond or below what the fundamentals warrant," said James Burkhard, director of oil market analysis at Cambridge Energy Research Associates. "So far, they've intensified this increase."
Much of the increased speculation has come from hedge funds, which continued to attract billions of dollars in fresh capital from wealthy investors. Some $38.1 billion flowed into hedge funds in the first quarter of 2004, according to Tremont Capital Management. Of that amount, Tremont's figures show, some $5.5 billion went to "macro" funds, which try to profit from speculating on broad global trends and geopolitical disruptions; another $3.9 billion went into funds specializing in futures. Both types are likely to be betting on oil price movements using options and futures contracts.[*]
"As more money moved into hedge funds, it has driven fund managers to look at oil, because there is only so much interest-rate position you can take," said David Kitson, head of global energy at J.P. Morgan in London.
Traders and analysts estimate that about 200 hedge funds now have significant positions in the energy markets. They said that some pension funds have also recently become avid investors in oil futures.
The flood of new entrants to the market has prompted some concerns, because investing in futures markets can be exponentially riskier than investing in equities. "This is not for widows and orphans," said Peter Beutel, president of Cameron Hanover, an energy-risk management firm in New Canaan, Conn. "Commodity prices move very quickly."
When they do, the least experienced players may be hit hardest. "This is a game that takes advantage of the weak," said Levine of Advest. "New speculators are the most ill-prepared for volatility."
Hedge fund managers often try to ride market trends, much like surfing a wave. Taken together, their bets can become self-fulfilling prophecies for a while. In May, when low inventories and news of violent attacks on oil executives and facilities in Saudi Arabia drove oil futures up, speculators piled on, according to market analysts. Their buying forced crude prices up even higher, attracting yet more investors betting on a continued rise, and so on in a classic spiral.
Some old market hands who based their strategies on historic trends and values were trampled in the stampede.
"It has been difficult to trade this market, because it has become detached from the fundamentals," Kitson said. "If you believe oil should be at $42 a barrel and it goes to $45, you're going to have a tough time" making a profit, he said.
Analysts noted that speculative spirals can push prices down as well as up, and that if the sentiment among the hedge funds were to turn bearish, oil prices could fall as far and as fast as they have risen, and overshoot market fundamentals in the other direction.
But for now, at least, those market watchers who were willing to hazard a prediction said the upward momentum in oil prices would probably continue. "I don't see anything stopping it from going to $50 in the short term," said Floyd Upperman, a commodity trading adviser based in Canal Winchester, Ohio.
signonsandiego.com
[*] Buying futures
Futures contracts are highly leveraged instruments. Leverage is the ability to control large dollar amounts of a commodity with a comparatively small amount of capital. In most cases, you can buy or sell futures with a good faith deposit, or initial margin of 10% or less of the value of the contract on delivery. The margin acts as a performance bond that is available to the futures broker to meet your obligations for potential losses on a futures position.
siainvestor.com
Bottom line: $5.5 billion and $3.9 billion invested in oil futures translate into a leverage upon $55 and $39 billion of oil deliveries.... |
