Oil May Drop to $30 as Investors Flee, Bernstein Says (Update2)
By Nicholas Larkin
Feb. 14 (Bloomberg) -- Oil will drop more than 30 percent to $40 a barrel in March and may drop to $30 as rising prices for storing crude lead to a `breaking point' that forces speculators to sell, Sanford C. Bernstein & Co. said.
Oil will slide because greater investment in commodity futures has driven the market into contango, according to analysts led by London-based Neil McMahon. The phenomenon occurs when futures prices rise above spot prices, often reflecting handling or storage costs.
``As storage fills up, storage costs rise and the contango widens,'' the analysts said in a February report. ``At some point, investors will reallocate money away from the commodity funds, causing futures prices to fall.''
Last month, New York-traded crude fell to $49.90 a barrel as warmer-than-expected weather spread across the U.S. and fuel inventories surged. Crude has since risen on a second production cut by the Organization of Petroleum Exporting Countries and a cold snap in the U.S., the world's largest energy consumer.
The ``breaking point'' could come in March if Saudi Arabia, OPEC's largest producer, fails to cut production below 8 million barrels per day, the level needed to keep the market balanced, the Bernstein analysts said. Spare capacity would rise, widening the contango and driving investors out.
Crude oil for March delivery fell as much as $1.56, or 2.6 percent, today to $57.50 a barrel on the New York Mercantile Exchange and traded at $57.81 at 1:16 p.m.
`Staggering' Flow
``The funds flow into commodities in recent years is staggering,'' McMahon and colleagues said. Net assets invested in the Goldman Sachs Commodity Index rose to almost $70 billion in 2006 from $15 billion in 2003, they said. ``The bubble is bound to burst.''
McMahon, 36, joined Bernstein from McKinsey & Co, in 2003. He previously spent three years in geology at BP Plc and BG Group Plc.
``You've got a lot of money coming into commodities from people who want to diversify from bonds and equities,'' Bernstein analyst Ben Dell said by phone today from New York. ``To some extent the bubble has burst. Making money on commodities is not as easy as it was.''
Bernstein has been looking at the problem of passive investment since June 2006, after the market curve changed into contango in Oct. 2005, according to Dell.
Rising and Losing
``After four years of fund flow into commodity futures, investors in oil are now struggling with how to generate a return with the curve in contango and a negative roll yield,'' he said. Investors can lose money even as oil rises when funds sell expiring contracts and then pay more for future contracts.
Bernstein said Oct. 16 that oil will probably fall to an average $50 a barrel in 2007 as inventories remain high and non- OPEC production rises. Crude has averaged $55.76 so far this year.
Among analysts predicting an increase in oil prices, Goldman Sachs Group Inc. says New York futures may rise to $71.50 a barrel this year because producer investment is ``significantly'' short of requirements.
The price of West Texas Intermediate, the benchmark U.S. crude, may average $69 this year, Goldman economist James Gutman said Feb. 8. The fuel reached a record $78.40 a barrel in New York on July 14.
Goldman Bullish
Goldman said in December 2005 that oil prices may go as high as $105 a barrel in a ``super spike'' period that may last until 2009, as production lags growing world demand.
Royal Bank of Scotland Plc agrees with Bernstein that oil will fall. Prices may drop to $45 a barrel by 2011 because ``the risk of severe supply disruption has receded'' and demand growth is slowing, RBS analyst Thorsten Fischer said Jan. 28. Production investment over the last few years will boost supply, he said.
Crude oil prices may plunge below $50 a barrel this quarter for the first time since May 2005 as rebounds become ``progressively shallower,'' chart analysts at Barclays Capital said last month.
Deutsche Bank, Europe's biggest securities company, last month cut its first-quarter crude oil estimate by 6 percent to $61 a barrel. The bank left its 2007 forecast unchanged at $62, citing production cuts by the Organization of Petroleum Exporting Countries.
``Even if Saudi Arabia cuts production, it is effectively creating underground storage, exacerbating the problem by encouraging further oversupply and making any future correction even worse,'' the Bernstein analysts said.
Oil May Drop to $30 as Investors Flee, Bernstein Says (Update2)
By Nicholas Larkin
Feb. 14 (Bloomberg) -- Oil will drop more than 30 percent to $40 a barrel in March and may drop to $30 as rising prices for storing crude lead to a `breaking point' that forces speculators to sell, Sanford C. Bernstein & Co. said.
Oil will slide because greater investment in commodity futures has driven the market into contango, according to analysts led by London-based Neil McMahon. The phenomenon occurs when futures prices rise above spot prices, often reflecting handling or storage costs.
``As storage fills up, storage costs rise and the contango widens,'' the analysts said in a February report. ``At some point, investors will reallocate money away from the commodity funds, causing futures prices to fall.''
Last month, New York-traded crude fell to $49.90 a barrel as warmer-than-expected weather spread across the U.S. and fuel inventories surged. Crude has since risen on a second production cut by the Organization of Petroleum Exporting Countries and a cold snap in the U.S., the world's largest energy consumer.
The ``breaking point'' could come in March if Saudi Arabia, OPEC's largest producer, fails to cut production below 8 million barrels per day, the level needed to keep the market balanced, the Bernstein analysts said. Spare capacity would rise, widening the contango and driving investors out.
Crude oil for March delivery fell as much as $1.56, or 2.6 percent, today to $57.50 a barrel on the New York Mercantile Exchange and traded at $57.81 at 1:16 p.m.
`Staggering' Flow
``The funds flow into commodities in recent years is staggering,'' McMahon and colleagues said. Net assets invested in the Goldman Sachs Commodity Index rose to almost $70 billion in 2006 from $15 billion in 2003, they said. ``The bubble is bound to burst.''
McMahon, 36, joined Bernstein from McKinsey & Co, in 2003. He previously spent three years in geology at BP Plc and BG Group Plc.
``You've got a lot of money coming into commodities from people who want to diversify from bonds and equities,'' Bernstein analyst Ben Dell said by phone today from New York. ``To some extent the bubble has burst. Making money on commodities is not as easy as it was.''
Bernstein has been looking at the problem of passive investment since June 2006, after the market curve changed into contango in Oct. 2005, according to Dell.
Rising and Losing
``After four years of fund flow into commodity futures, investors in oil are now struggling with how to generate a return with the curve in contango and a negative roll yield,'' he said. Investors can lose money even as oil rises when funds sell expiring contracts and then pay more for future contracts.
Bernstein said Oct. 16 that oil will probably fall to an average $50 a barrel in 2007 as inventories remain high and non- OPEC production rises. Crude has averaged $55.76 so far this year.
Among analysts predicting an increase in oil prices, Goldman Sachs Group Inc. says New York futures may rise to $71.50 a barrel this year because producer investment is ``significantly'' short of requirements.
The price of West Texas Intermediate, the benchmark U.S. crude, may average $69 this year, Goldman economist James Gutman said Feb. 8. The fuel reached a record $78.40 a barrel in New York on July 14.
Goldman Bullish
Goldman said in December 2005 that oil prices may go as high as $105 a barrel in a ``super spike'' period that may last until 2009, as production lags growing world demand.
Royal Bank of Scotland Plc agrees with Bernstein that oil will fall. Prices may drop to $45 a barrel by 2011 because ``the risk of severe supply disruption has receded'' and demand growth is slowing, RBS analyst Thorsten Fischer said Jan. 28. Production investment over the last few years will boost supply, he said.
Crude oil prices may plunge below $50 a barrel this quarter for the first time since May 2005 as rebounds become ``progressively shallower,'' chart analysts at Barclays Capital said last month.
Deutsche Bank, Europe's biggest securities company, last month cut its first-quarter crude oil estimate by 6 percent to $61 a barrel. The bank left its 2007 forecast unchanged at $62, citing production cuts by the Organization of Petroleum Exporting Countries.
``Even if Saudi Arabia cuts production, it is effectively creating underground storage, exacerbating the problem by encouraging further oversupply and making any future correction even worse,'' the Bernstein analysts said.
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