– Uncertainty still looms for commodities-focused strategies as Middle East tensions resurface –
The deadly missile strike against Iranian general Qassem Suleimani at Baghdad Airport on 3 January elevated oil prices amid immediate concerns over renewed conflict in the region. Brent Crude surged to more than USD70 a barrel following the attack, and prices stayed above USD68 early last week, before falling back to just under USD65 on Monday.
But while there may be potential for further episodic bouts of volatility further down the line, commodity-focused hedge fund managers believe that for now, the recent surge has likely hit its ceiling, with higher moves ultimately requiring a material impact on global supply.
Doug King, CEO and CIO of RCMA Capital’s Merchant Commodity Fund, says the killing of the Iranian general increased Middle East risk levels once again, after a lull in tensions following the drone strikes on Saudi Arabian oil facilities in Abqaiq in September.
Brent Crude briefly spiked to USD71 per barrel after last September’s Saudi Aramco strike, with roughly half of the country’s oil production and an estimated 5 per cent of all global supply temporarily knocked out. Oil saw a 20 per cent rise – its biggest overnight surge since the first Gulf War – later settling around USD62.
But King, a veteran oil and commodities specialist, believes the Abqaiq attacks demonstrated global consumers “carry a much better buffer than at any time in the past”. He adds that for prices to push beyond USD75 per barrel, markets will need to see evidence of a material disruption to crude supply coming out of the Middle East.
“The pertinent question to ask is if, how, what, where crude supply has been disrupted? The answer is that as of today there is no disruption to the supply of crude coming out of the Middle East,” he observes. “We are also approaching maintenance period for the global refinery complex and that should peak between March and April. The heavier the maintenance, the less the immediate demand for crude.”
King’s Merchant Commodity Fund, which manages about USD138 million in assets, gained 6.21 per cent last year.
Elvis Pellumbi, founder and chief investment officer at London-based CF Partners Capital Management, which trades oil, gas and renewables with a long/short event-driven approach, agrees that the market does not currently believe in a shortage-of-oil situation.
“We know for a fact that Opec has a lot of spare capacity following the decision to reduce production over the last year and a half, and the attack on Saudi last year showed that the impact was very short lived,” Pellumbi notes.
So how are commodity hedge fund managers positioning their portfolios in light of this month’s events?
“For us, it’s not just about buying or selling crude oil flat price based on headlines telling us about tensions in the Middle East,” says King.
Expanding on this point, he explains how his strategy aims to identify and capitalise on false pricing signals which may influence real world crude trade flows, shipping rates and refinery run intentions.
“Such false signals, and their effects, create mis-pricing across the term structure (futures curve), inter-commodity relationships (refinery cracks or refined petroleum spread), and trade arbitrages,” he adds.
Meanwhile, Jean-Louis Le Mee, chief investment officer of London-based Westbeck Capital’s Energy Opportunity Fund, believes the recent move at the front of the oil curve is “probably” capped at USD70 for now, adding that CTAs are essentially maximum long on the commodity.
He believes the back end of the oil curve currently presents more attractive opportunities for his portfolio.
“Very aggressive US shale hedging for 2020 and 2021, together with tight physical oil markets, now translate into record ‘backwardation’ in Brent,” he notes of the gap between the current spot value of oil and futures market prices.
“The positive roll yield is 10 per cent over 12 months and 15 per cent over 24 months – the back end has never been so cheap versus the front. Back end call options are extremely cheap. This is where we have most of our risk,” he says of his fund’s positioning.
Le Mee believes the apparent evacuation of US troops ahead of Iran’s retaliatory strike last week may still leave room for a de-escalation. “Oil could lose some risk premium short-term at the front of the curve.”
More broadly, the global push for reducing carbon emissions, and the structural concerns surrounding fossil fuels, ultimately outweigh the short-term technical considerations in energy markets, according to Pellumbi.
“Most of the flows in securities are passive in my view and again, will reverse,” he adds. “There are hardly any generalist investors left in the energy sector and I don’t suspect that higher oil prices for a few weeks will bring them back.”