The growth of shale oil production and the increasing dominance of financial markets on the oil price mean the Organisation of Petroleum Exporting Countries (Opec) is reversing its distaste for hedge fund investors.
“We are more globalised, and the impact of the financial markets on oil continues to be magnified. In this world, we believe we should adapt to these new changes and therefore reach out,” Mohammad Barkindo, secretary-general of Opec, told reporters at CERAWeek in Houston at the beginning of March. Barkindo added he would be meeting Houston-based hedge funds to get their thoughts on how to clear the oil glut.
This change in attitude follows years of hostility directed at hedge funds and derivatives market participants.
A recent bearish Energy Information Administration report has predicted US shale production will reach 4.96 million barrels a day in April – the highest level since March 2016. At the beginning of March this year, West Texas Intermediate fell below $50, as long positions among hedge funds dropped nearly 6%, according to a Commodity Futures Trading Commission (CFTC) Commitment of Traders report.
Barkindo has reportedly met with BBL Commodities Value Fund, Citigroup, Ospraie Management and Taylor Woods Capital, and plans to meet others in London and New York. Insiders say he has quizzed fund managers about the reasons banks have moved away from commodities, and the increase in automated trading. Some traders suggest Opec has finally acknowledged the importance of financial market sentiment for the oil price, and is panicking that further decreases in hedge funds’ long crude positions will undo the production cut agreement set out in Vienna on November 30.
“This shows in general that Opec is more concerned,” says Vincent Elbhar, co-founder of GZC Investment Management, a Switzerland-based hedge fund. “They are trying to find more ways to get prices to stay up, and to understand how the speculative community functions, in the hope that somehow they can find a compromise on how they will allow prices to sit within the $50–60 band.”
Analysts argue the financial market is a key liquidity provider to oil markets, but Opec has been heavily critical of a corner of that market it has long considered detrimental to pure market drivers of supply and demand.
“Under the age-old businessman’s creed, one is encouraged to speculate, so as to accumulate,” according to Opec, in Gambling on oil: The price the market pays, an official Opec Bulletin from April 2015. “And there is nothing wrong with that. But surely the extent of one’s trading activities should not be to the point where the very structure of the market you are working in is distorted and destabilized.”
Former secretary-general Abdalla Salem El-Badri, who led Opec’s unsuccessful attempts to weaken US shale production and other market players by flooding the market, often referred to derivatives and financial market impacts on the oil price as the “phantom of the energy market”.
Opec is trying to find more ways to get prices to stay up, and to understand how the speculative community functionsVincent Elbhar, GZC Investment Management
The organisation seems to have abandoned that approach: a day before its production cut meeting on November 30 last year, the Saudi Arabian delegates sat down with Mark Couling, head of crude oil at Vitol, Pierre Andurand (formerly at Vitol), who runs the Andurand Capital fund, and a trader from Lukoil’s Litasco. However, some members of the hedge fund community warn the group risks angering those not in attendance at the meeting by not disclosing exactly what was said.
“If you’re opening up new channels of information, that opens all kinds of interesting arguments,” says Adam Hoffman of WoodedPark Strategies, a Houston-based risk management consultancy. “If they’re divulging details on how cuts are going to be made, these are all points every market participant would have liked to have known at the time. You can imagine the fury among hedge funds when some realised there’d only been a couple of guys at the table.”
A former assistant general counsel at the CFTC points out that while the regulator takes an active interest in Opec meetings, it is not illegal to find and use information ahead of other players in US commodities markets, but taking part in price manipulation is.
Ken Irvin, a lawyer at Sidley Austin in Washington, DC, agrees this is murky territory for hedge funds. “Certainly I could make out a potential manipulation scheme – for example scheming to withhold or flood supply, releasing false information to the market – arising from hedge funds dealing with Opec. I would hope, however, that all involved were smart enough to govern any such communications so as to avoid issues, like agreeing not to trade on any material non-public information obtained through such meetings.”
Promised land pricing
Opec has long aimed to be perceived as an oil price volatility compressor, targeting a certain price per barrel at which members can operate their budgets effectively. That, the group has argued, puts it at odds with hedge funds interested only in profiting from price swings. According to Hoffman, however, the group is now far more interested in revenue and market share, making dialogue with financial markets completely natural.
“Opec is interested in the highest revenue (price times volume produced and sold), and they aren’t necessarily interested in stability, in and of itself,” says Hoffman. “Whether it’s a $36 price or a $336 price, they don’t care – so long as they make sure their revenues are as high as they possibly can be for the longest time period achievable.” Some suggest that in wooing hedge funds whose long positions are currently buoying prices, Opec is simultaneously trying to collect reinforcements for its war on US shale.
Elbhar argues Opec is right to make a move now given the chance of a hedge fund oil exodus, the bullish nature of US shale production and the sudden dip in prices. Even if the production organisation has been spooked, it needs to tread carefully before it runs out of options, and financial market players are aware of that. “The only thing they can do is act, to oversupply the market in periods to send a strong signal to shale producers that they are not having a free ride,” he says.
The week on Risk.net, June 16–22, 2017Receive this by email