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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