Oil brings surge in speculators betting on prices
AP DataStream
Midland Reporter Telegram 09/19/2004
By Gregory Zucherman and Henny Sender
The Wall Street Journal
Oil has become a speculator's paradise. Surging energy prices have attracted a horde of investors -- and their feverish betting on rising prices has itself contributed to the climb.
These investors have driven up volume on commodities' exchanges and prompted a large push among Wall Street banks and brokerage firms and many European banks to beef up energy-trading capabilities. As the action has picked up in the past year, those profiting include large, well-known hedge funds, an emerging group of high-rollers, as well as descendants of once-highflying energy-trading shops such as Enron Corp.
Enron alumnus John Arnold now runs a $600 million Houston-based hedge fund, Centaurus Energy LP, which has racked up more than $200 million of profits in the past year alone thanks to big bets on oil and natural gas, according to investors. Oil-industry veteran Boone Pickens runs two hedge funds that are among the biggest players in oil and natural gas, and have scored gains of more than $550 million in the past two years. Giant hedge funds, including Paul Tudor Jones's $9 billion Tudor Investment Corp and D.E. Shaw & Co., an $8 billion firm, also have scored big gains.
Energy prices have been rising for more than two years, amid growing demand from a rebounding global economy and worries about disruptions of supply from the Middle East, Russia and Venezuela. Such market forces affect the price of "U.S. benchmark crude" quoted every day. But energy prices also reflect daily trading, speculating and haggling in financial markets, such as the oil-futures market, where investors actively bet on future energy prices through what are essentially financial instruments.
The Friday price, for example -- September crude-oil futures fell 84 cents to settle at $47.86 on the New York Mercantile Exchange -- refers to the cost of a futures contract: an agreement to pay so much for, in the case of this month, a barrel of crude oil in September. Like any speculative market, this one is strongly affected by liquidity, volatility, and demand -- and all of those elements have increased sharply in the past year.
The investors have been betting on higher prices. As of last week, noncommercial investors, which include hedge funds and similar investment entities, made about 28 percent of all futures bets on higher crude-oil prices at the New York Mercantile Exchange, up from less than 13 percent of all such "long" positions at the beginning of 2002. Their bets on falling prices have declined to 21 percent of all such wagers, compared with 28 percent of these "short" positions three years ago.
All the added demand has affected prices because it comes as constraints on energy supplies emerge. "The marked rise in the net long positions of noncommercial investors in oil futures and options since May 2003 has increased net claims on an already diminished global level of commercial crude and product inventories," said Federal Reserve Chairman Alan Greenspan in June of this year. "Oil prices accordingly have surged."
Analysts believe speculators are playing the role of marginal buyers, sending prices higher than they would otherwise be, but doing little to alter the basic upward trend driven by broader market pressures, such as high demand. Jeff Curry, head of commodities research at Goldman Sachs, estimates crude-oil prices would be in the low $40s a barrel were it not for these speculators.
Wall Street banks and brokerage houses have ramped up their efforts to profit from energy by boosting trades for their own account. Gains at a fund run by Citigroup Inc. called AAA Capital are 24 percent this year, according to investors. These companies have also been aggressively marketing trades based on their commodity indexes -- which generally are about 70 percent composed of energy investments -- to U.S., European and Asian pension plans. These plans have been shifting to energy investments in recent months.
The impact of financial investors probably will grow, because a slew of major investment companies have shifted into energy trading recently. Rubicon Fund Management LLP, a $3 billion London-based hedge fund, recently hired William Callanan, a former Soros Fund trader, to lead its effort. Other major hedge funds, including Citadel Investment Group of Chicago, New York's Vega Asset Management, and Ritchie Capital Management LLC of Geneva, Ill., also are scouring the market for veteran energy and electricity traders.
On Friday, Morgan Stanley announced it will spend $775 million to buy the rights to 24 million barrels of oil to be produced over the next four years from Anadarko Petroleum Corp. A year ago, the big Wall Street firm bought oil and gas reserves in the Gulf of Mexico for about $300 million from another oil producer, Apache Corp. The deals are part of an effort by Morgan Stanley to expand into outright ownership of energy assets, rather than simply trading for customers and for Morgan Stanley's own account. Such ownership gives the company a more-direct way to play the oil market.
Many European banks also are stepping up their involvement in energy trading. For example, Benoit de Vitry, head of commodities trading at Barclays Capital PLC in London, says he has hired 26 former Enron energy traders, mostly in London.
The strategies in this oil-investment surge range from simply buying oil futures on the Nymex to sophisticated derivative plays. Hedge funds increasingly have been going to brokerage companies to buy complex combinations of options and other derivatives. Funds often find trading via the brokerage firms provides greater liquidity than at the Nymex, and there's no danger they will find themselves accidentally taking delivery of actual crude oil. Brokerage firms often allow big funds to make trades with favorable financing terms, with more leverage than on an exchange.
Buying an index, like the Goldman Sachs Commodity Index, has become a popular strategy because it lets the investor profit from the general rise in prices for energy and other commodities. As much as $20 billion is now tied to these indexes.
In another type of play earlier in the year, funds aggressively bought near-term oil-futures contracts and sold longer-term contracts, betting on a spike in prices. That meant oil futures for more-distant delivery were getting much cheaper than near-term contracts. More recently, these funds have shifted gears, figuring energy prices will remain high for a while, narrowing the price difference between near-term futures and long-term futures. Futures tied to crude oil priced in 2006 have jumped to $39 a barrel, up from about $29 a few months ago.
While it's difficult to get an exact figure on how big a role financial investors are playing in the energy markets, it's clear it has been growing. There currently are about 450 commodity-trading advisers, or CTAs, many of which trade energy actively, managing almost $70 billion in assets. That's up from 136 funds managing about $20 billion just four years ago, according to Tremont's TASS Research.
Meanwhile, at least 50 hedge funds emphasize energy trading, while a group of large so-called macro funds, which try to make big money from global economic trends, have shifted into the market in the past year or two. All these investors tend to use leverage, or borrowed money, to amplify their bets; some CTAs borrow $10 for every $1 of money they invest in some trades. Pickens is considered to be among the players using the most leverage in the market. Super-slim interest rates have encouraged these investors to borrow money.
Hedge funds, CTAs and pension plans control about 15 percent of the $200 billion or so tradable energy market, according to analysts and traders, including oil futures. They also trade various related positions, such as energy stocks. While they are a relatively small part of the market, some of these investors have an outsize impact because they trade more actively than other participants in the market, like oil companies and airlines, analysts say.
Some of the newer energy traders, who have ridden the rising tide of oil prices, base their faith in prices' continuing to rise primarily on market concerns about sufficient supply. "We're very bullish on energy," says Peter Thiel, a co-founder of online-payment company PayPal Inc. who now runs hedge fund Clarium Capital Management, which is up 125 percent in less than two years, and calls investments in energy his best trades. "I expect oil to go to $80-$90 (A BARREL)by 2010."
But many other investors are drawn to energy simply because it is one of the few markets that has been rising.
Some players have gone against the trend and bet on price declines. Former Morgan Stanley strategist Barton Biggs turned negative on oil prices earlier this year, likening the rise in oil to the surge in technology stocks in the late 1990s that led ultimately to much lower prices. The stance has hurt his $2 billion New York hedge fund, Traxis Partners. People close to the matter say George Soros's Soros Fund Management LLC hasn't been a major player in the energy market, selling some oil stocks in the last quarter. Marc Rich, once a dominant player in the oil markets and still active from his home in Switzerland, underestimated how far prices would climb, according to people familiar with the matter.
Among those getting stung by rising prices are some players very familiar with the energy markets. Energy companies are naturally long the energy markets and use the futures market to hedge themselves by selling oil and other energy-related contracts. Moreover, in the past few years, they have been asked by their bankers to lock in prices by using the futures market. But recently, as oil keeps rising, these hedges against falling prices have been losing positions. Some other longtime energy traders have been selling oil futures contracts short, or borrowing the contracts and selling them, hoping to replace them in the future at a lower price.
The speculative fervor has waned somewhat as the price of crude oil has set records and neared $50 a barrel, indicating some doubts about an inexorable rise in oil prices. Net long positions by these noncommercial traders in all petroleum products stand at 76 million barrels, which is down from 125 million barrels a few months ago. In May of last year these investors had shorted, or bet against the rise of petroleum prices, to the tune of about 50 million barrels, according to the Commodity Futures Trading Commission.
Some figure there is a limit to how high prices can go before consumers alter their behavior, or alternative sources of energy become a focus. As fast as they've been to jump on the energy bandwagon, these investors could jump off just as rapidly were oil prices to begin to fall.
"It all points upwards at the moment," says Jamie Philip, a commodity trader at Aspect Capital Ltd., a London-based hedge fund. "But we'll be quick to get out if there are any signs of the reversal."
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