Another sign of the times:
Oil hits troubled waters
Oil prices have leapt as investment banks and hedge funds join the
'black gold rush', and the long-term future for supply is bleak,
writes Robert Winnett
September 14, 2004
http://www.theaustralian.news.com.au/common/story_page/0,5744,10757920%255E28737,00.html
A LARGE warehouse in Amsterdam may seem an unusual place to attract
the City's top traders and hedge funds.
But, in the past few months, Morgan Stanley has been accumulating
warehouse space in the Netherlands to store its hottest new property -
oil. This and the tankers that have been hired by the investment bank
illustrate just how important oil is now becoming in the City of
London and Wall Street.
Morgan Stanley may be among the most advanced of the new breed of oil
speculators, but, over the past year, many banks and hedge funds have
joined the "black gold rush". With the stock market proving
lacklustre, the oil market has been a godsend for the banks, which
describe it as the "new Nasdaq".
Speculators have helped to drive oil prices to near record levels -
peaking at almost $US50 ($72) a barrel last month.
Oil is the talk of the City with millions of pounds being made every
day, and oil traders are among the most sought-after employees. "If
you can spell derivative, you can earn six figures, and anyone who can
navigate his way round the oil market is offered $US1 million just to
sign a contract," said one trading executive.
There have traditionally been two distinct oil markets. The first is
the futures markets in London and New York that trade the right to buy
oil at a predetermined point in the future. About a sixth of all oil
is sold this way, although most contracts are traded and then lapse
without oil changing hands.
This "paper" market, the main stamping ground for speculators, acts as
a benchmark for the price of oil in the second market - crude bought
direct from oil companies. If prices on the futures market rise too
far above the so-called physical market, oil users such as airlines
and petrol dealers pull out, so prices fall. If prices on the futures
market are lower than in the physical market, the users pile in,
pushing up prices.
However, this traditional equilibrium has been rocked by short-term
speculators dipping in and out of the futures market. This has led to
sharp rises in the price and far more volatility.
Meanwhile, banks such as Morgan Stanley are also beginning to move
into the physical market to buy oil - or even entire oilfields. Morgan
Stanley recently won the contract to supply fuel to United Airlines,
and Goldman Sachs recently bought 10 million barrels of oil.
A senior oil company executive said: "Even within this firm, the
mechanics of the market are not widely understood. When oil prices go
up, everyone talks about fundamentals and geopolitics, but the role of
speculators and banks is now very significant."
In the City, Barclays, Morgan Stanley and Goldman Sachs are leading
the charge into oil but several secretive hedge funds are also
wagering hundreds of millions of dollars in the market every day and
reaping the dividends. Over the past few months, ABN Amro has also
built up an oil-trading team.
"We have a database of about 300 people in London who are capable of
trading oil so, as you can imagine, they are very highly desired,"
said one bank executive.
The International Energy Authority, an intergovernmental organisation,
recently criticised the role of speculators. They have also been
attacked by French and US ministers. Alan Greenspan, chairman of the
US Federal Reserve Board, said speculators had caused oil prices to
"surge".
A secret analysis of the market carried out by a big European oil
company recently found that speculators were adding between $US7 and
$US8 - or between 15 and 20 per cent - to the price of a barrel of
oil.
A senior executive at one oil firm said: "This is the hottest oil
market I have ever seen. There has been a massive increase in
hedge-fund activity. And what we call non-commercial interests (those
who do not use oil for their business) has doubled recently.
"A lot of new banks are coming in and all the speculation is very
disruptive."
Much of the trading by hedge funds has been driven by sophisticated
computer-trading models. The models, known as "black boxes", use
complicated formulas to determine trades.
Over the past few years, a number of hedge funds have added the oil
markets to their trading systems as the price of oil tends to rise
sharply after periods of strong economic growth. Hedge-fund insiders
say oil is an excellent short-term bet. The sharp rises and falls in
the market over the past month are symptomatic of such
computer-generated trading.
Prices rose sharply to almost $US50 a barrel, at which point the
computers kicked in to automatically sell huge positions. Last week,
the computer trading models kicked in again to cause the biggest daily
fall in oil prices for three months - a drop of 4 per cent to $US42.81
a barrel.
Jeffrey Currie, head of commodities research at Goldman Sachs said:
"The number of speculators is typically correlated with high economic
growth. They work off macro-economic trading models.
"Equities are anticipatory assets - you buy them when you expect the
economy to do well - but commodities such as oil are spot assets that
you buy when the economy has done well."
Man Group's AHL hedge fund and Aspect Capital Management are two
London-based funds that have moved heavily into oil.
Aspect oil expert Stephen Butler said: "We are one of the biggest in
Europe and have built up our exposure over the past 18 months. We
probably have up to $US250 million exposure a day on the London and
New York markets. Our trading is determined by computer so we don't
have the emotional factor. It has worked well on the energy markets
and has been one of our best-performing sectors."
But apart from the short-term speculators, the investment banks have
also identified a looming "oil crunch", which has encouraged them to
move aggressively into the market.
Goldman Sachs calculates that for the first time this year demand for
oil will outstrip the world's capacity to refine and distribute it.
Benoit de Vitry, head of commodities at Barclays Capital, said: "The
oil system has cracked. There is a lack of refinery and distribution
capacity. The spare capacity is now down to 1 million barrels a day.
People are not worried about having their meal on the table today, but
fears are growing about the future."
According to Goldman Sachs, the capacity of oil tankers and oil
refineries has been dropping since the early 1980s because of a lack
of investment, and the crunch will come this year.
Since 1983, real spending on energy exploration and production has
fallen by 49.5 per cent. Building the required infrastructure will
take years, possibly more than 10. The International Energy Agency
forecasts that over the next 30 years the energy industry globally
will require $US16,000 billion in new investment to catch up - and it
is not clear where this money will come from.
Apart from the oft-quoted, short-term oil price, there is also a
lesser-known market in long-term oil futures - the right to buy oil in
five years' time. This has traditionally been a rather staid market,
and the price of a barrel of oil in the long-term market has been
around $20 for most of the past 20 years.
However, over the past 18 months, the price has rocketed to $35 a
barrel as the speculators have moved in.
The bleak, long-term outlook for oil prices is also why banks have
begun to buy up oil supplies directly. Morgan Stanley and Deutsche
bank recently bought the rights to 36 million barrels of oil between
2007 and 2010 direct from a North Sea oilfield. The pattern of supply
and demand for oil this decade is also undergoing a fundamental
change.
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