Study questions long-only strategies in oil markets
on July 21, 2010

US oil stocksJul10.pngAs the chart above from Petromatrix shows, total US stocks of crude, gasoline, distillate and jet kero this year (red line) remain very over-supplied in the short term, by comparison with previous years.
A major reason for this is the move by pension funds to adopt long-only positions in the commodity future markets, in the belief that crude markets are fundamentally tight.
However, this week the Financial Times summarises a timely new study of commodity markets, by Prof Joelle Miffre of Edhec Business School. This argues that investors need instead to understand the difference between:
o Backwardation, “when commodity producers are more prone to hedge than commodity consumers“, and the future price is lower than today’s
o Contango, “when commodity consumers outnumber commodity producers, leading to excess demand“, and the future price is above the current value
They recommend that “to earn a positive risk premium, investors should take long positions in backwardated markets and short positions in contangoed markets“.
The team’s research suggests this strategy would have earned the investor a commodity risk premium of 12% a year between 1992-2008. Whereas the long-only strategies currently followed by pension funds earned only 2% a year. Edhec therefore concludes that “passive long-only strategies as advocated by traditional indexers perform less well“.

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