Oil Traders Increase Bets for $80 Crude on Supply Concerns

Bloomberg

Alejandro Barbajosa

July 4, 2005

Record oil prices may increase to $80 a barrel this year, options contracts on the New York Mercantile Exchange show. Investors are speculating OPEC won't produce enough oil to compensate for any disruption to supplies.

New York Mercantile Exchange data show 6,900 options contracts outstanding that allow the buyer to purchase crude oil for December delivery at $80 a barrel, compared with an average of 77 in January. The probability that oil will top $75 a barrel when the December crude contract expires is 21 percent, according to Adam Sieminski and Michael Lewis, strategists at Deutsche Bank AG, up from 5 percent at the start of the year.

``The perception is that the risk of higher prices now is higher than at the beginning of this year,'' Deutsche Bank's Sieminski said in an interview. ``The market is so tightly balanced that issues like a nuclear confrontation with Iran could add a great deal of worry'' about supplies.

The Organization of Petroleum Exporting Countries, the producer of about 40 percent of the world's oil, is pumping almost as much crude as it can to increase inventories before an expected fourth-quarter peak in consumption. Crude oil reached a record $60.95 on June 27, deepening concern that the cost of energy would slow economic growth.

Growth Concern

Oil prices have surged 53 percent in the past year on concern that producers and refiners will strain to meet demand for products ranging from gasoline to diesel and heating oil.

U.S. Treasury Secretary John Snow on June 28 said high prices are hurting the world economy. German Chancellor Gerhard Schroeder on June 27 called for more transparency in global oil markets to stem speculation and lower prices from levels that are threatening to crimp expansion. The Organization for Economic Cooperation and Development in May cut its global growth estimate for this year and next, partly because of rising energy costs.

The Paris-based OECD now expects economic growth of 2.6 percent this year for its 30 member nations, down from its previous semi-annual forecast in November of 2.9 percent, the group said in May. In 2006, growth will reach 2.8 percent instead of 3.1 percent.

Oil companies are profiting from the price surge. Exxon Mobil Corp., BP Plc, Royal Dutch/Shell Group, Chevron Corp. and Total SA, the five largest publicly traded oil companies, reported combined net income of about $85 billion last year, when prices averaged more than $41 a barrel.

Shares of energy companies are rising. The Morgan Stanley Capital International World Energy Index, one of 10 industry groups making up the global equity benchmark, is leading gains with a 17 percent surge this year. The broader MSCI World measure has lost 1.8 percent in the period.

$100 `Disastrous'

Saudi Arabia's oil minister Ali al-Naimi on June 14 said his country, OPEC's largest exporter, can increase oil production by 1.5 million barrels a day from the 9.5 million a day the kingdom plans to pump in July, for a total of 11 million barrels a day.

One of his predecessors, Sheikh Ahmad Zaki Yamani, who was the Saudi oil minister when Arab countries declared an embargo on exports to the West in 1973, said that $100 a barrel oil ``isn't far-fetched.''
For that to happen, he said, ``it needs the help of a political event or a military adventure, like attacking Iraq. It would be disastrous,'' he said on June 28 at a conference near London.

A supply disruption of ``a couple of million'' barrels a day could send prices to $105, William Dudley, the chief U.S. economist at Goldman, Sachs & Co. in New York, said June 14. Global oil demand will rise to a record 86.4 million barrels a day in the fourth quarter, the Paris-based International Energy Agency forecasts.

Output Cut

``We've certainly seen people asking for prices on $100'' contracts, said Orrin Middleton, who markets options and other securities for Barclays Capital in London. ``This was way off people's radars 12 months ago. They now believe there's a possibility, but it's going to take a supply disruption to take us there.''

Oil shipments from Iraq, which in May pumped an average 1.78 million barrels a day, were cut by about 50 percent on two occasions last year following attacks on pipelines. When the U.S. invaded the country in March 2003, production plummeted from 2.48 million a day in February of that year to 140,000 a day in April, according to Bloomberg data.

`Forget $60'

The daily average volumes of crude oil options trading on Nymex in the five months through May was 55,036, more than the 46,237 that traded on average in 2004, data on the exchange's Web site shows. The record was a daily average 80,710 in 2002.

``What they're playing is the possibility of a supply interruption,'' said Garrett Smith, who managed Boone Pickens's BP Capital Energy Equity Fund until he left earlier this year to start his own hedge fund. ``If you look at the history of supply disruptions, while they're not predictable as to when they will occur, they are predictable in that they will occur.''

Oil may also stay high amid concern about Iran. Mahmoud Ahmadinejad, who was elected president of Iran June 24, said he plans to pursue a nuclear energy program to generate electricity. The U.S. says Iran wants to build weapons from that program and calls Iran a sponsor of terrorism. Iran has rejected the charges.

``A surprise in the oil market would be if the U.S. attacks Iran,'' Sheikh Zaki Yamani said at the conference of the Centre for Global Energy Studies, which he founded and chairs. ``Prices would shoot up, and then forget about $60'' a barrel, he said.

Iran, OPEC's second-biggest oil producer after Saudi Arabia, pumped about 3.9 million barrels of crude oil a day in May, according to Bloomberg estimates. Saudi Arabia's output was 9.5 million barrels a day in the period.

Russian Oil

Oil production from Russia, which pumps the most oil outside OPEC, had its smallest gain this year in May, according to the Energy Ministry, as investments slowed after the dismantlement of OAO Yukos Oil Co., once the biggest oil exporter. Slowing growth this year will lead to a decline in output in 2006, Paul Horsnell and Kevin Norrish, analysts at Barclays Capital, said last month.

Increasing volatility in the oil markets is boosting trading in options. On June 13, a total of 2,602 options to buy crude for December delivery at $80 a barrel traded on Nymex.

Two years ago, the options market attracted little interest in contracts that anticipated a surge in prices. In September 2003, when prices averaged about $28 a barrel, options to buy December crude at $50 traded on just two days.

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