economics

January 29, 2010

Traders Bet on an Oil Breakout

Filed under: Uncategorized — ktetaichinh @ 6:41 am
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After the quietest trading period in more than two years, traders are starting to bet crude oil will wake from its slumber.

Since October, prices have largely ranged from $70 to $80 a barrel, the narrowest four-month band since mid-2007. An oil “fear gauge”—the CBOE Crude Oil Volatility Index—early last week fell to the lowest level in more than two years.

But in the past few sessions, trading in the crude-oil options market has shown signs of reviving, awakened by worries that China is putting the brakes on growth and concerns about political turmoil in Washington. While oil prices remain within that trading band, the volatility index has bounced off the bottom, according to some traders.

[COMMOD1]

At New York Mercantile Exchange, daily crude-oil option trading volume jumped over 150,000 lots on Thursday and Friday, up nearly 50% from the 2009 daily average. To traders, it is a sign prices may soon be on the move. “We are getting to the point where things are coiled so much and it’s going to break out,” said Michael Korn, president of Skokie Energy Corp, a brokerage in Princeton, N.J.

Southwest Airlines, Newfield Exploration Co. and Chesapeake Energy Co. all recently said they have increased their hedging positions to protect against price swings.

Jeff Grossman at BRG Brokerage in New York said his firm saw increased buying of put options late last week, or options that give an owner the right to sell at a certain price, as investors tried to protect against a further downward move for oil.

New swings, either up or down, likely will be triggered by expected changes in supply or demand. Some expect oil prices to tumble, taking a cue from last week’s selloff in stocks, which fell on fears of another downturn in the global economy. Others say prices will soar because of stronger economic growth and fuel consumption. On Monday, Morgan Stanley in a research note predicted oil would reach $95 a barrel by year end.

Oil prices are forecast surge to $100 a barrel, but not until next year. Emerging market demand is helping to erode a glut of oil, and when mature economies in the OECD recover from recession, prices could breach the key $100 mark.

On Tuesday, the price of the crude-oil contract for March delivery fell 55 cents a barrel, or 0.7%, to $74.71 on Nymex.

The recent calm is in contrast to the wild swings of the past two years. Oil jumped to more than $147 a barrel in mid-2008 from $70 a barrel earlier that year, before sinking again into the $30s. The moves stirred political debate and consumer outrage. Many pointed fingers at so-called speculators, blaming them for roiling the energy markets.

While Commodity Futures Trading Commission regulators struggled to agree on ways to limit speculative trading, calm has returned to the markets.

As a result, some financial traders—those who make bets on prices with no interest in the fuel itself—moved away from the energy markets. At Nymex, financial traders slashed 20% of their short positions, or bets that prices would fall, and 15% of their long bets in the fourth quarter of 2009, according to CFTC data. That contributed to a 13% decline in total outstanding contracts for crude oil.

As volatility dried up, more traders moved “some of their allocations toward equities and elsewhere,” says Ryan Cournover, head of energy trading at Lighthouse Financial Group, a New York investment bank and securities firm.

Some returned in January to build positions for the new year. Open interest rose 4% this month, but still is down 9% from the end of September.

For oil companies, “the stability gives them a little bit more assurance on where the oil prices will be with a little bit incremental hedging,” says Robert Morris, a Citigroup Inc. analyst. Companies use derivatives to lock in prices for futures sales. According to Citigroup, exploration-and-production companies are 33% hedged on projected production for the next 12 months, up from 22% at the end of 2008.

Still, some traders say wariness about big moves in oil is growing. “The need for hedging is completely intact,” says Philippe Laraison, global head of energy trading with Société Générale. The bank is seeing a regular flow of hedgers coming into the markets. Many companies were stung by the recent boom-and-bust cycle. The market’s intraday volatility is still substantial, encouraging the hedging.

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