Oil’s Rout Outpaces Its Advance
By CLIFFORD KRAUSS
HOUSTON, Sept. 18 — Michael Rose, the director of the energy trading desk at Angus Jackson in Fort Lauderdale, Fla., has made a lot of money for his clients by riding energy prices up the escalator of recent years.
But with fading risks of supply disruptions from things like a hurricane in the Gulf of Mexico or the rise in tensions with Iran, he started changing his position earlier this summer.
“Crude is coming down because it was way too high,” Mr. Rose said. “We had so much fear put into this market, that somewhere between 10 and 20 dollars were fear premium.”
“The reality is it is today’s market,’’ he added in an interview on Friday as crude oil traded at its lowest levels since March. “And today the weather is nice and the Iranians are lowering their aggressive posture.”
As crude oil prices have plunged about 18 percent over the last six weeks, from nearly $77 a barrel to less than $63 last week, many traders like Mr. Rose say they have been dumping and selling short stocks and futures contracts. In many cases, traders are betting against the very bets they made only a few weeks ago.
As a result, some of those with the biggest bets may be caught in the cross-fire, just as Amaranth Advisors, a big hedge fund, appears to have been blindsided by the sudden drop in the price of natural gas.
It is hard to know whether the reversal is just temporary or reflects something more lasting. Oil prices rebounded slightly on Monday after BP announced that production from its hurricane-damaged Thunder Horse oil platform, the largest in the Gulf of Mexico, would not start until 2008. Light crude oil for October delivery closed Monday at $63.82 a barrel, up 0.77 percent, on the New York Mercantile Exchange.
But for now, traders and hedge fund managers have been selling faster than they bought earlier this year. Some of the selling may be overshooting, as traders try to unwind their futures contracts. But speculation by energy traders that the price of oil is going down, or at least settling at lower levels than expected a few weeks ago, appears to be spreading.
“If you are one of these black-box guys, the market looks like it is in bad shape,” said William Wallace, a trader on Nymex for Man Financial. “I would not at all be surprised if we give up some more ground.”
There are several reasons for the changing market. Oil companies that built up their inventories as prices rose are beginning to release those excess supplies to customers. Tensions in the Middle East have eased. Economic growth may be slowing. New drilling in the Gulf of Mexico suggests there are large deepwater reserves that seismic technology will make possible to tap.
Perhaps most of all, the surprisingly calm weather this hurricane season has alleviated fears of another serious production disruption like the one that followed Hurricane Katrina a year ago.
Phil Flynn, a vice president and senior market analyst at the Alaron Trading Corporation, a brokerage firm in Chicago, said the big losses at Amaranth from the fall of natural gas prices should be a cautionary tale for other hedge funds that invest in commodities like oil and gas.
“There is always the possibility of a sell-off that could put a fund in trouble,” he said. “A lot of these funds are trading markets that are very volatile, and usually the higher the price that any market goes, the higher the risk of correction.”
Mr. Flynn noted that trading volume for natural gas and crude oil set record last Tuesday, as a lot of commodity funds and traders exited positions before their options contracts became due on Friday and as they anticipated the expiration of the October futures contracts this week.
In a research note on Friday, Wells Capital Management predicted that oil prices would head for about $50 a barrel. “An oil crisis based on excessive oil dependence is hard to reverse, but one based on excessive risk premiums could quickly reverse,” it suggested.
The futures market can be fickle and those trading in it are still betting that prices next year will rise from current levels. The prices set for future delivery of a barrel of crude at different points next year average $67 to $68, and for 2008 the range is $69 to $70.
But traders note that the prices contracted for next summer now are about $12 below the delivery prices set only a few weeks ago.
Secretive and unregulated, and deploying proprietary trading systems, market speculators were blamed by some, including some oil industry executives, for driving prices higher than justified by supply-and-demand fundamentals.
Oil contracts held by hedge funds, the private firms run by traders who have large stakes in the risks and rewards of their clients, have doubled since 2001 as oil prices spiked. The growth in the number of big investors, like pension funds, in futures trading has led to large and rapid capital inflows into crude oil.
But traders say they were just responding to the uncertainty in the market and the fears that energy suppliers, already operating on a razor edge, might face a sudden disruption that would send prices sharply higher.
Still, the rise in oil prices from an average of $28 in 2003 has made commodity traders far superior performers than investors in the stock market. And for a while, that performance encouraged even more investors to pour even more money into oil futures.
Now some of the traders themselves wonder if they will drive prices too low by selling off once-profitable positions that are turning sour.
“On the way up, there is buying greed,” said Gary Pokoik, who manages Hedge Ventures Energy, a Los Angeles hedge fund. “And on the way down there is a selling panic. The drop could snowball.”
He added that the problems revealed at Amaranth could be repeated. “There is always a manager out there who uses a lot of leverage to make a call that goes sour,” he added. “When they are wrong, they get wiped out.”
Mr. Pokoik said that his modest-size fund, about $40 million, was tilted 70 percent toward long positions in energy stocks only two weeks ago, expecting prices to rise again. Now his portfolio is evenly split between long and short positions as he has begun to bet that stocks in the oil service sector will fall further.
For him the essential ingredient to energy price stability is good weather, with the possibility of more large drops in crude prices if the coming winter is warm.
Art Gelber, president of Gelber & Associates in Houston, a consulting firm that advises hedge funds, said there was a “change in psychology” in the oil market about two weeks ago right after Chevron announced the discovery of huge oil fields in deep waters of the Gulf of Mexico.
Even though those fields will not begin pumping oil for several years, he said “the fear of short supply due to Indian and Chinese demand as well as political instability has given way to optimism that we may have additional control over domestic supply.”
Traders, however, are also planning for the day when prices will rise again. “We will be long again when prices are a lot lower and Wall Street hates the group,” said Adam Newar, founder and manager of Eden Capital Management in Houston, a $220 million hedge fund that has been shorting a number of energy stocks the last four to six months.
But for the moment he is being cautious, taking careful bets on the other side of the action. “Oil,” he said, “can easily go into the 50’s here.” |
