Hedge funds betting on higher price oil in futures contracts

Bloomberg/Fuel Fix:
Oil investors are buying contracts that will only pay out if crude rises well above $100 a barrel over the next four years — a clear sign some believe today’s bust is sowing the seeds of the next boom.

The options deals, which brokers said bear the hallmarks of trades made by hedge funds, appear to be based on the belief that current low prices will generate a supply crunch as oil companies cut billions of dollars in spending on developing fields. The International Energy Agency forecasts that non-OPEC supply will suffer its biggest decline in more than two decades this year.

“The market faces a supply crunch in the next 24 months,” said Francisco Blanch, head of commodities research at Bank of America Merrill Lynch in New York. “Some hedge funds are betting that oil prices will need to rise sharply to bring demand down again — that’s why they are buying deep out-of-the-money call options.”

Over the last month, investors have bought call options — giving the right to buy at a predetermined price and time — for late 2018, 2019 and 2020 at strike prices of $80, $100 and $110 a barrel, according to data from the New York Mercantile Exchange and the U.S. Depository Trust & Clearing Corp.

Even before the most recent flurry, some investors had already built super-bullish positions. The largest number of outstanding contracts — or open interest — across both bullish and bearish options contracts for December 2018 is for calls at $125 a barrel. For December 2020, it’s for $150 calls.
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“Large spending cuts on the back of low oil prices will lead to the demand and supply gap widening from 2018 onwards, if not earlier,” Abhishek Deshpande, oil analyst at Natixis SA in London, said. “This is likely to push oil prices up as early as 2017,” he added.
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The biggest cutbacks in exploration budgets appear to  be in offshore production which is more expensive to drill and carries more risk.  The shale producers may benefit the most in the US as the plays are relatively well known at this point and the production costs have have been dropping.  Several major oil companies have switched their focus to the Permian Basin  in West Texas.

Countries like Nigeria and Libya are also having difficulty overcoming military operations against their oil production and Canada has had recent setbacks caused by out of control fires.

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