Exchange data show hedge funds and other large speculators have accumulated a record-breaking number of North Sea Brent futures and options contracts equal to almost 265m barrels of oil – the equivalent of almost three days of global oil demand,” reports the Financial Times.
Last week, hedge funds and speculators increased their bets in crude futures and options for a fifth week in a row. They raised their net long positions in WTI crude futures and options to 276,051 contracts and Brent futures and options to 271,929 contracts, the highest level since records began in 2011. Hedge funds are betting big on oil. Let us have a look at some of the logic behind such moves.
Oil prices surge
In recent weeks oil rallied strongly, up more than one-third within three months. Earlier Brent crude had fallen by more than half from $115 in June to $55 in January. Since then oil started recovery and now Brent is trading at around $66 and WTI at $57 per barrel. Analysts have raised oil price forecasts. Bank of America Merrill Lynch says, “The market seems to have found a spot price low, and we lift our end of 2Q15 targets for WTI and Brent to $59 and $63 a barrel.”
Yemen conflict pushes up oil prices
As Gulf producers use Yemen’s southern coast to ship oil, the conflict may disrupt supplies. Market fears that violence in Yemen can spill over and affect oil supply across the region.
Falling U.S. rig count pulls down production
According to Baker Hughes, a leading oil field service provider which also compiles industry data, the U.S. oil-drilling rigs count has fallen to 703, less than half from a peak of 1,609 in October. The decline is for a record 20 weeks in a row and the number is at its lowest since 2010. The number of oil drilling rigs is an indicator of the level for activity in the oil industry. Oil rigs are needed to service oil wells and maintain production. New production wells also need to be drilled and added to make up natural decline in oil production.
More than 50% cut in drilling operation has already started impacting production. Lower deployment of drilling rigs is creating an apprehension of production- drop. The US oil production declined for a second week amid a drop in drilling activity. It is natural to expect that US oil production to decrease further in next quarter.
On the other hand, the International Energy Agency (IEA)’s data reveal that world demand for crude oil is rising. The IEA has raised the forecast of average global oil demand by 1.1 mb/d to 93.6 mb/d for 2015. This would make the price stronger in coming months. Oil traders are beginning to turn bullish. And hedge funds are betting on oil.
The announcement of Shell’s $70 billion bid for BG is the largest proposed oil and gas deal since Exxon’s $80 billion acquisition of Mobil in 1998. Shell’s offer represents a 50% premium to BG Group’s on the 90-day average trading price. Wide spread provides opportunities for hedge funds to make quick profit. The deal is subject to approval by shareholders of both companies and other regulators. Opinions differ as to whether the deal will finally go through or not. Hedge funds managers believe the spread is high, relative to the risks of the deal not being completed. They have placed bets on this uncertainties to make money.
Very recently the oil industry had witnessed a merger deal between two top oilfield services giants Halliburton and Baker Hughes. ExonMobil is keeping an eye over BP. More takeovers in the industry are expected that would create more opportunities for hedge funds.
“The recent $12bn wave of E&P equity bailed out some potential distressed sellers. Nonetheless, the Shell deal highlights one major’s willing to do a deal seemingly assuming a robust recovery in oil prices,” says Williams Featherston, Managing Director of UBS Investment Research.
To conclude, the oil prices fall by more than half and then smart recovery by over one-third all within a span of less than ten months have provided huge opportunities for hedge funds managers to grab and reward their investors.