Why commodity hedge funds are now betting on an imminent oil price surge

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Hedge funds which generated striking returns in volatile energy markets last year are now preparing for a major rebound in oil in 2021, with post-vaccine travel demand, potential inflation hedges, and surging emerging markets growth all combining to push prices higher this year and beyond.

Already, the price of Brent Crude hit USD55.76 on Monday, its highest price since March 2020 during the start of the coronavirus pandemic.

Bullish hedge fund managers now believe several factors could surface to drive prices beyond USD100 in the next few years.

Jean-Louis Le Mee, co-founder and CIO of London-based energy-focused hedge fund Westbeck Capital Management, predicts an oil demand bounce “much faster that what consensus is still modelling” as the vaccine roll-out helps unleash the pent-up demand for travel and transport.

Sector-specific hedge funds which trade energy stocks and other basic materials soared some 33 per cent last year, according to new data from Hedge Fund Research, while individual oil-focused managers scored even higher gains over the 12-month period.

The Andurand Commodities Fund, the main strategy of high-profile oil hedge fund manager Pierre Andurand, surged 68 per cent last year – a strong return to form for the fund after suffering annual losses in recent years. The Andurand Commodities Discretionary Enhanced strategy rose a spectacular 154.1 per cent in the same period.

Meanwhile, the Westbeck Energy Opportunity Fund, London-based Westbeck Capital Management’s high-flying flagship fund, soared 84 per cent in the 12-month period to the end of December.

The strategy - which takes a long/short directional approach to trading oil equities, futures and options – made big gains from being short front oil in March and April, while a long bet on certain oil equities – chiefly exploration and production stocks – between April and June also strengthened its performance.

“We suffered in September and October as oil equities retested the March lows, hitting our drawdown limit and being forced to cut most of our risk,” said Le Mee. “But we reacted quickly on the vaccine and our equity positions were the main driver of a very strong end to the year, and strong start to 2021 so far.”

Looking ahead, Westbeck is now “very bullish” on oil and oil equities, Le Mee told Hedgeweek.

“What is happening in Asia strongly suggests that, once the vaccines have been deployed, we are going to see enormous pent-up demand for travel play out,” he observed. “We would not be surprised to see oil summer demand exceed 2019 levels. If that demand view plays out, the market underestimates how quickly global spare capacity will vanish.”

He continued: “Obviously the -1mbd Saudi cut as well as the Democrat sweep only reinforces our bullishness. US production has lost 2.5mbd and won’t bounce quickly. The shale model has changed.”

He suggested the days of “runaway” US production growth are gone. Consolidation, refinancing needs, deteriorating geology, and “desperation” hedges laid out at “completely wrong prices” will further handicap US production, along with regulatory headwinds from the incoming Biden administration.

At the same time, ESG (environmental, social and governance) trends are forcing oil majors and large E&P names to place carbon neutrality at the forefront of their agenda, which means more investment in renewables - and less in fossil fuel.

“For the first time ever, it could be an oil bull market where higher prices fail to translate into more upstream capex, at least for the majors. That supply-demand set up in our view, in itself, could lead to very high prices in 2021 and beyond.”

Coupled with the potential for renewed inflation globally, with the Fed “outprinting everybody else”, Le Mee said the potential flows into commodities – particularly oil – for inflation hedge purposes are “simply enormous”.

“In the long term, a big push towards green energy and electric vehicles in the US, of course, is bad for oil demand. But we are talking 2025 at the earliest before it really matters for oil markets,” he said. “In the short-term, more fiscal stimulus, more USD de-basement should be good for oil demand growth, especially in non-OECD.”

A weaker dollar is also likely to drive strong growth in emerging markets, which in turn are the drivers of oil demand growth, he explained.

“There is now a high probability, in our view, oil will return to USD100-plus over the next two or three years.”

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Hugh Leask
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