By Chris Gillick
Summer hurricanes can be a boon to energy traders who bet that eventful weather will push up the prices of natural gas. But with nary a storm on the horizon, this year’s season turned out to be a bust. Good thing other trades have heated up returns this year.
Hedge funds focused on energy have gained a median 12.79% this year through August. That’s a far better result than in 2008, when markets plunged in the second half of 2008 and whipped many long-biased players, leading to a median loss of 13.63%, according to the Absolute Return database. Energy funds are also beating out the broader hedge fund index, which gained a median 9.16% through August.
By and large, this year’s winners are relying on relative value plays. As the per-barrel price of crude oil moved into a firm trading range between $62 and $75, and as natural gas prices fell to seven and a half year lows (below $3 per million BTUs), energy funds have had to make do with less trending and more grinding it out.
“We definitely had a rangebound summer,” says Dennis Crema, co-founder and chief executive of London-based $1.5 billion BlueGold Capital Management. Unlike last year, when the fund’s 209% gain was derived mostly from one-way bets, Crema and his crew have stuck with spread trading recently. “Last year our trading was about 75% to 80% directional. This year it’s pretty evenly split between the two styles.”
BlueGold is again well ahead of the benchmarks, netting 50.4% through August. One trade that has worked well is going long the crack spread, industry parlance for selling a primary form of oil while buying its derivative products—essentially a bet that an economic recovery will boost prices for the derivative products more quickly than it will for those of crude oil. One of BlueGold’s particularly successful pairings was to sell West Texas Intermediate crude oil and buy Reformulated Blendstock for Oxygen Blending gasoline. The August RBOB/September WTI spread climbed from $6 in March to $14 in late July. On the last day of trading for the August RBOB contract, the spread blew out to $16.
Paul Touradji’s $2.7 billion Touradji Capital Management is also relying heavily on relative value strategies this year. Touradji Global Resources Fund had gained 6.7% through August, according to an investor, following a 13% gain last year.
This year energy funds have also profited from contango, a situation whereby long-dated contracts trade at a significant premium to the front, or nearby, months—an opportunity for traders to lock in profits as long as they can deliver oil physically on the back end. To complete that strategy, however, traders must secure storage space in the interim. Earlier this year, as the February-October spread ballooned to $15, storage tankers got locked up quickly. Even with tanker storage costing about $0.90 a barrel per month, plus the cost of dock fees and maintenance, the trade was still a guaranteed money maker: a profit of about $1.88 per month a barrel.
Last year’s collapsing energy prices—between July and December 2008, the spot price of oil fell to $30 from an all-time high of $147.11—whipsawed two noted fund managers: Boone Pickens’ long-biased BP Capital, based in Dallas, and Dwight Anderson’s Ospraie Management of New York, among others. BP Capital, which managed $3.6 billion at its peak, steered its equity and commodity funds to big losses in 2008 (64% and 98%, respectively). Ospraie, which once managed $3.5 billion, closed its flagship fund last year following a 38.6% loss, led in part by a decline in oil and gas producer XTO Energy. The fund’s demise was also hastened by a provision that allowed investors to leave the fund after a 30% decline.
Yet neither manager is out of the game. Pickens set up two new funds this year that are both off to a good start. BP Capital’s Energy Equity Fund II and Energy Fund II had returned 15% and 105%, respectively, as of July. The firm’s assets, however, have fallen to $500 million.
Anderson, who at 42 is nearly 40 years younger than Pickens, has also wiped his slate clean. On July 1, Anderson launched two new vehicles, Ospraie Equity Fund and Ospraie Commodity Fund, which now manage a combined $200 million. The firm also continues to manage its $1 billion Special Opportunities Fund. A spokesman for Anderson declined to comment.
The timing and strength of the economic rebound continue to worry traders. They are also uneasy about the possibility of more commodities trading regulation in the form of position limits—a restriction the Commodity Futures Trading Commission is considering in response to last year’s big price swings.
The massive run-up and collapse of energy and commodity prices in 2008 has led to intense debate. John Arnold, founder of $5 billion Centaurus Advisors and considered one of the world’s best natural gas traders, told the CFTC in August that he sees no conclusive evidence of a positive correlation between trading volume and volatility. International Energy Agency’s Medium Term Oil Market Report and a July report issued by the Institute for Energy Research both support Arnold’s position. A study released in August by Rice University’s Baker Institute for Public Policy did blame speculators, however, contradicting findings from the CFTC under the Bush administration.
As such, the CFTC may take over some regulatory functions from the New York Mercantile Exchange and enact position limits to discourage speculation. Naturally, portfolio managers are concerned. “Should the CFTC become overly aggressive in reducing futures position limits, or should they start trying to regulate the over-the-counter or physical trade, I believe the markets could be hurt, and there could be unintended consequences,” says Mark Brockett, partner and energy portfolio manager at $1.3 billion Vermillion Asset Management. Prior to joining Vermillion in 2006, Brockett traded the energy book for Louis Bacon’s Moore Capital Management for 13 years. “Market participants may be drawn to offshore exchanges and venues operating outside the jurisdiction of the CFTC,” he says.
Recently, the CFTC deferred enacting (from September to November) proposed position limits in financially settled natural gas contracts. That decision came after Arnold testified on August 5, arguing that the commission should scrap or postpone its position-limit plans. Arnold advocates imposing hard limits on physical contracts as they approach expiry, because he thinks such restrictions would reduce volatility.
Not everyone stands to lose out on position limits. Drew Gilbert, co-founder and managing partner of Vermillion, says the limits would help his firm because of its smaller footprint. “Some of the largest players will have to cut down their size,” he says. Viridian, Vermillion’s flagship fund, trades up to 42 different commodities and has lost 10% this year through August, according to investors. Last year, the fund netted 26% and reports an average net annual return of 11%.
On a technical trading basis, crude has been stuck in a range and has had trouble breaking the all-important $75 resistance level. Despite this challenge and the stagnant economy, some traders hold a fundamentally bullish outlook for oil and gas, most notably BlueGold’s Crema. “We feel fundamental economic data has improved and will have a positive effect on risk assets,” he says.
Crema expects crude oil to rise to between $85 and $90 a barrel by yearend, particularly as demand for diesel fuel rises both seasonally and in the restocking phase of the economic cycle. Also working to maintain stability is the Organization for Petroleum Exporting Countries, which has been reducing output. Says Crema: “They have shown great discipline.”
Vermillion’s Brockett concurs with Crema’s bullish outlook, at least in the medium term. “Inventories of crude oil in Cushing, Oklahoma, are declining and oversupply is starting to come down,” he says, referring to an important and closely watched U.S. oil storage location.
As for natural gas, low prices may not last long if one big option bet is any indication. The curve is steep for the months through January 2010, and in mid-August, one hedge fund bought 10,000 contracts of January 2010 calls with a $10 strike price just as the spot price fell to multiyear lows of $2.50 per million BTUs. As of press time, the spot price has rallied to $3.50 and the January 2010 NYMEX futures contract was trading at about $5.30.
For traders who missed out on hurricane season, a cold winter might help to make up the difference.
