Oil Drawing Hedge Funds

[Rudey]

http://www.reuters.com/newsArticle.j...toryID=6368857

Oil Drawing Hedge Funds
Wed Sep 29, 2004 02:52 PM ET

By Raj Rajendran
LONDON (Reuters) - Oil could hit $60 a barrel as hedge funds gear up to return to the only major asset market currently offering the strong fundamentals, clear trading direction and speculative scope they love.

Volatility, vital for making money, is drawing hedge funds back to the oil market as it plays in stark contrast to currencies and bonds which have lost momentum or stuck to tight ranges for months, money managers and analysts say.

"A lot of hedge funds are playing it purely for the volatility," Steven Miller, energy director at hedge fund Bakersteel Capital, told Reuters.

"There is no limit to the upside from a technical basis," he said.

That is music to the ears of market players who expect 2004 to be the hedge fund industry's worst year in a decade, triggered by stalling stock and bond markets.

U.S. crude oil futures have rocketed 53 percent so far this year, hitting a record of $50.47 on Tuesday and lingering around $50 per barrel.

Driving crude prices higher is the fastest world economic growth in 20 years -- only marginally crimped by soaring prices -- that has created huge demand for oil that currently runs at 82 million barrels per day.

The risk to disruption of supplies, the list of which ranges from tribal attacks in Nigeria to sabotage in Iraq, adds a premium despite efforts by oil cartel OPEC, itself hemmed in by capacity constraints, to raise production.

"There could be a big surge in activity if things look unstable from a geo-political point of view, then hedge funds will seize on the opportunity to jump in," Miller said.

"The spare capacity, which acts as a buffer is not there, so there will be a lot more volatility."

VOLATILITY KNOCKS

The greater the volatility, the greater the attraction of the market, given the current dearth of opportunities elsewhere.

"Hedge fund involvement has increased in the market place as it would have done in any market that had the volatility the oil market has had this year," said Rob Laughlin, director of energy at GNI Man Financial.

Fundamentals also make the market attractive to traders.

Oil is entering its seasonal peak consumption period as the northern hemisphere winter approaches, bolstering the near term bullish outlook.

Some long term bulls also highlight the potential of rapidly increasing consumption in China and India to keep prices bubbling away.

The combination of technical and fundamental factors could see the return of big long speculative positions that would lift U.S. crude to $60 a barrel. "An increase in net length in heating oil and the potential tightness of this market suggests that speculative interest is likely to grow further," said Barclays Capital energy analyst Kevin Norrish. Speculative net long positions across the three New York Mercantile Exchange (NYMEX) oil futures contracts amounted to 115,500 lots in the first week of January, peaking at 144,200 in the first week of March when hedge funds were making handsome profits from the trade.

That speculation had eased to 27,600 lots by Sept. 14, growing to 39,800 for the week to Sept. 21, according to data from the Commodity Futures Trading Commission.

"Speculative length in the oil market has declined more than what economic activity would suggest. Accordingly, we believe that speculative length will rise from the current 80 million barrels to 130 million," energy analysts at Goldman Sachs said in a note to clients.

This will push the premium for speculative behavior from $2.50 a barrel to $4, based on Goldman's estimate that every million barrels of speculative length is worth 3 cents a barrel.

Also waiting in the wings are traders who cashed out their Spring long positions and booked profits during the Summer.

"The trend followers got shaken out and have not come back. The next entry might get underway if the market breaks lower, where the risk reward is better," said Russell Newton, fund manager at commodities hedge fund Global Advisors. (additional reporting by Pratima Desai)