What really triggered oil’s greatest rout

A range of factors, both economic and political, were also at play. The recent rise in raw goods has been fueled in part by the U.S. Fed pumping cash into the markets by purchasing $600 billion in bonds. This program has pushed interest rates extraordinarily low, making borrowing essentially free once adjusted for inflation. Investors have been using the super-cheap money to buy into commodity markets. But the Fed’s program is slated to end on June 30.

“Funds were likely to take profits before June when the direct (Fed) bond purchases stop. All were eyeballing each other to see who would take profits first,” said a London-based oil trader.

China, the world’s fastest-growing consumer of commodities, also is tightening monetary policy to tamp growth rates and control inflation, raising the prospect of a slowdown in demand for oil.

The political risk premium built into oil prices also came under scrutiny last week. The unrest sweeping through the Arab world – home to over half of world oil reserves – has boosted oil this year. The only major supply disruption so far is from Libya, where war has cut off at least 1 million barrels a day.

“We’ve been in a world thinking there’s more risk, more risk, more risk,” said Sarah Emerson of Energy Security Analysis Inc. “People took this week, and the news of bin Laden’s death, to simply reflect. They stopped and said, maybe there’s less risk.”

GAME OVER

Put all these factors together, and they amounted to a reason to sell. Traders and brokers who spoke with Reuters speculated that macro funds like Soros and others, which had been aggressively overweight commodities, were cutting the portion of their portfolio allocated to commodities. Because those positions had grown so large, even a small rebalancing would amount to billions and billions of dollars in contracts sold. After weeks of thin trading in Brent oil futures, Thursday’s trade volume hit a record.

Early Thursday, investment advisory firm Roubini Global Economics had also joined the fray, telling clients for the first time in years to cut commodities in their macro portfolios. Many funds were merely taking months of handsome profits off the table.

Yet Thursday’s rout certainly produced casualties.

By the afternoon New York time, some of the world’s biggest money managers thought they smelled blood. Several banks and funds seemed to be selling oil in an orderly fashion, even if the price drop was extraordinary. But could a hedge fund be struggling for survival?

They wondered whether any major commodities funds were on the losing end of bullish oil bets, and were getting forced by margin calls from brokers into dumping massive positions.

One trader at a major bank in New York called a colleague at one of the world’s largest hedge funds. During the conversation, they exchanged notes, suspicious that one or more commodities-focused hedge funds might be facing a moment of reckoning, one of the participants said.

No fund could be pinpointed. By the end of the day, the person said, they were less suspicious — a view shared by week’s end by many market participants who spoke to Reuters. No one was naming a major hedge fund in dire trouble, or a computer trading algorithm that went haywire.

And unlike last May’s flash crash in equities markets — when stocks fell by a similar 9 percent margin in just minutes — Thursday’s decline came in rolling cascades, playing out over at least 12 hours.

Even after Brent LCOc1 fell to settle around $110 by the end of the day, crude prices were still up 38 percent from a year ago.

“Since prices have been advancing well beyond any reasonable measure of value, Thursday’s declines felt more like orderly corrections than chaotic panics. There was no sense that anyone was ready to jump from the window,” said oil analyst Peter Beutel of Cameron Hanover in Connecticut.

CASUALTIES

The day left some commodities-heavy funds nursing wounds – weekly losses of 10 to 20 percent, according to several fund managers who invest in other hedge funds.

Two of the sources said that London-based BlueGold, a fund known for taking aggressively bullish directional bets on oil in the past, had sizable losses. It was not immediately clear how much the fund dropped, and BlueGold declined comment.

One money manager said of BlueGold’s head trader Pierre Andurand: “He’s had tougher weeks so I don’t think it’s game over.”

Fund sources also cited losses at $20 billion Winton Capital, of around 2.2 percent, on Thursday. FTC Capital, a $300 million European commodities fund, lost 4 percent in one of its larger funds, the sources said. Neither fund was available for comment.

In the space of just hours, the drop in the price of crude oil had shaved nearly $1 billion off the cost of supplying the world’s daily oil needs. That could be good news for gasoline consumers. But Eric Holder, the U.S. Attorney General who has recently formed a government working group to investigate manipulation in oil markets, had a blunt warning for oil traders. He wants proof the savings are being passed on to end users.

“This working group was created to identify whether fraud or manipulation played any role in the wholesale and retail markets as prices increased. If wholesale prices continue to decrease, fraud or manipulation must not be allowed to prevent price decreases from being passed on to consumers at the pump,” Holder said on Friday.

Reuters