Oil price pushed
higher by new investors
May 2, 2006 - International Herald Tribune
Author(s): Jad Mouwad And Heather Timmons
A global economic boom, sharply higher demand, extraordinarily tight
supplies and domestic instability in many of the world's top
oil-producing countries in that environment, higher oil prices were
inevitable.
But crude oil is not merely a physical commodity that fuels the world
economy, powers planes, trains and automobiles, heats cities and
provides fuel for electricity. It has also become a valuable financial
asset, bought and sold in electronic exchanges by traders around the
world. And they, too, have helped push prices higher.
In the latest round of furious buying, hedge funds and other
investors have helped propel crude oil prices from around $50 a barrel
at the end of 2005 to a new record of $75.17 on the New York Mercantile
Exchange last month.
In January 2002, oil was at $18 a barrel.
With gasoline in the United States now costing more than $3 a gallon,
or about 80 cents a liter, energy prices may be a political liability
for the Bush administration. But for outside investors hedge funds,
investment banks, mutual funds, pension funds and the like the
resurgence in the oil market has been a golden opportunity.
"Gold prices don't go up just because jewelers need more gold; they
go up because gold is an investment," said Roger Diwan, a partner with
PFC Energy, a Washington-based consulting firm. "The same has happened
to oil."
Changes in the way oil is traded have contributed their part as well.
On Nymex, oil contracts held mostly by hedge funds essentially, private
investment vehicles for the wealthy and institutions, run by traders who
share the risks and rewards with their partners rose to more than 1
billion barrels last month, twice the amount held five years ago.
Beyond that, trading has also increased outside official exchanges,
including swaps or over-the-counter trades conducted directly between,
say, a bank and an airline. And that comes on top of the normal trading
long conducted by oil companies, commercial oil brokers and funds held
by investment banks.
"Five years ago, our futures exchange was a small group of physical
oil players," said Jeffrey Sprecher, the chief executive of
Intercontinental Exchange, the Atlanta-based electronic exchange where
about half of all oil futures are traded. "Now there are all sorts of
new investors in trading commodity futures, much of which is backed by
pension fund money."
Such trading is a 24-hour business. And more sophisticated electronic
technology allows more money to pour into oil, quicker than ever before,
from anywhere in the world.
In the Canary Wharf business district of London, for example, the
trading room of Barclays Capital was filled with mostly young men in
identical button-down blue shirts, staring intently at banks of computer
screens where the prices of petroleum products crude oil, gasoline, fuel
oil, naphthene and more flicker by.
Occasionally, one of the traders broke from his trance to bark
instructions into a black speaker box to a floor broker a couple of
miles away. On a television screen above the traders, President George
W. Bush was telling America to "get off oil."
Experienced oil traders are in heavy demand, and average salary and
bonus packages are close to $1 million a year, with top traders earning
as much as $10 million. The rush of new investors into commodities has
meant a rash of new clients for banks like Barclays.
Meanwhile, Lehman Brothers and Credit Suisse have recently beefed up
their oil trading teams to compete with market leaders like Goldman
Sachs and Morgan Stanley.
"Clearly, the big attraction of commodity markets like oil is that
they've been going up," said Marc Stern, the chief investment officer at
Bessemer Trust, a New York wealth manager with $45 billion in assets.
"Rising prices create interest."
So far this year, oil prices have gained 18 percent; they were up 45
percent in 2005 and 28 percent in 2004, a performance far superior than
the Standard & Poor's 500, whose gains in these years have been in the
single digits. And to some extent, the rising price of oil feeds on
itself, by encouraging many investors to bet that it is likely to
continue.
"The hedge funds have come roaring into the commodities market, and
they are willing to take risks," said Brad Hintz, an analyst with
Sanford C. Bernstein, an investment firm in New York.
Energy funds make up 5 percent of the global hedge fund business,
with about $60 billion in assets, according to Peter Fusaro, principal
at the Energy Hedge Fund Center, an online research community.
The gains on the oil market have attracted a fresh class of
investors: pension funds and mutual funds seeking to diversify their
holdings. Their investments have been mostly channeled through a handful
of commodity indexes, which have ballooned to $85 billion in a few
years, according to Goldman Sachs. Goldman's own index holds more than
$55 billion, triple what it was in 2002.
Pension funds have been particularly active in the last year, said
Frederic Lasserre, the chief of commodity research at Societe Generale
in Paris. These investors, seeking to diversify their portfolio, have
added to the buying pressure on limited commodity markets.
While all this new money has contributed to higher prices by some
estimates perhaps as much as 10 percent to 20 percent the frantic
trading ensures that even the biggest players, including the major oil
companies, cannot significantly distort the market or tilt it
artificially in their favor. It also makes oil markets more liquid,
meaning a buyer can always find a seller.
"The oil market has been driven by speculators, by hedge funds, by
pension funds and commodity indexes, but the fact of the matter is that
it's mostly been driven by the fundamentals," said Craig Pennington, the
director of the global energy group at Schroders in London. "Prices are
supported by the fact that there is no spare capacity."
The inability to increase output fast enough to keep up with global
demand accounts for most of the oil price rise over the last three
years, analysts say. And until more investments are completed in oil
production and refining, markets will remain on edge, with the slightest
bit of bad news likely to push prices up further.
"The reality is that the world has no supply cushion left," said
Edward Morse, an executive adviser at Hess Energy Trading, a New York
oil trading firm.
Political strife and circumstance played major parts as well. A
crippling strike in Venezuela's oil industry in 2002, the invasion of
Iraq, civil unrest in Nigeria, and last summer's hurricanes in the Gulf
of Mexico, among other things, have all contributed to a pinching of
supplies.
According to Cambridge Energy Research Associates, an energy
consulting firm owned by IHS, Iraq is 900,000 barrels a day below its
prewar output; Nigeria is off 530,000 barrels a day; Venezuela is still
400,000 barrels below its pre-strike production; and the Gulf of Mexico
remains down by 330,000 barrels a day. In all, this amounts to more than
two million barrels of disrupted oil supplies, Cambridge Energy
estimates.
The latest reason for gains on energy markets is the growing fear
that the diplomatic standoff between the Western powers and Iran over
nuclear technology will get out of hand.
"All the risk," said Eric Bolling, an independent trader on Nymex,
"has been on the upside."
In the end, supply and demand call the tune. "The idea that
speculators can systematically push the price up or down is wrong," said
Robert Weiner, a professor of international business at George
Washington University and a fellow at Resources for the Future, a
nonpartisan think tank. "But they can make it more volatile. They can't
raise water levels, but they can create waves."
Not all bets have turned out to be profitable. Veteran commodity
market traders have been stymied by the high prices of oil, which have
exceeded their expectations, and many now predict that a steep decline
in prices is ahead. But they have been wrong so far.
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