PBR Petroleo Brasileiro ADR

By Ira Iosebashvili 

Some traders anticipating a rebound in oil are making an indirect bet: wagering on energy companies and the currencies of oil-producing nations instead of the commodity itself.

Their approach is spurred in part by contango, an occasional event in which the current price of oil is lower than prices for future delivery. The phenomenon, which prevailed this year, makes it more expensive to bet on oil futures, as it forces investors pay up when they trade out of old contracts and into newer ones.

To avoid pricey futures, traders have turned to other wagers as a proxy for oil. Some of the trades are looking smart compared with a pure oil bet: The krone, the currency of major oil producer Norway, has fallen just 2.8% since the start of November, a period in which Brent futures dropped 27% to an 11-year low. The dollar bonds of Brazilian oil giant Petróleo Brasileiro SA have fallen 10% over the same span.

Simply betting on the price of a commodity "is not a thing anymore," said Michael Hague, global head of commodities research at Société Générale in New York. "These days it's more about going long and short, using more exotic investments."

U.S. oil prices surpassed prices on the global market for the first time in four years on Tuesday, adding one more twist in an already topsy-turvy energy market. Light, sweet crude for February delivery gained 33 cents, or 0.9%, to $36.14 a barrel on the New York Mercantile Exchange. Brent, the global benchmark, fell 24 cents, or 0.7%, to $36.11 a barrel on ICE Futures Europe, setting a new low dating back to July 2004.

Contango isn't the only factor driving these proxy trades. Many investors believe that oil producers' currencies and energy-firm securities are due to bounce back. Others want to avoid the hefty losses that have scarred raw-materials markets this year.

Some are seeking to boost returns, for instance by purchasing interest-bearing assets such as the Petrobras bonds or by pairing a bet on oil-related investments with a bet against something else.

Money managers say using these roundabout approaches can mitigate losses and cut volatility. Mr. Hague is recommending clients play a potential bounce in beaten-down crude prices by investing in a basket made up of oil-sensitive currencies such as the Russian ruble, Norwegian krone, Mexican peso and Canadian dollar. While all are down, none matches the 32% loss in U.S. oil prices this year.

Many traders warn that proxy bets carry their own risks. The strategy can increase the chances of making a bad call, and could magnify losses if markets turn treacherous and correlations--a measure of how much various asset prices move together--break down.

"It's hard enough to be right on one thing, and now, you have to be right on at least two," said Tobias Moskowitz, a professor at the University of Chicago Booth School of Finance.

An investor betting on a currency as a way to play an oil price rebound, for example, must account for a whole slew of additional factors not strictly related to oil, such as central-bank policy and the strength of the U.S. dollar. An energy company's securities may be hurt by dozens of idiosyncratic, company-specific factors or a broader selloff in stocks, and could decline even if oil prices rise. Bond investors must carefully gauge interest-rate movements and a company's creditworthiness.

At the same time, correlations that had been in place for months can go awry at inopportune times, Mr. Moskowitz said.

"We build models based on long-term relationships, but during times of extreme market stress they can change dramatically, and usually not in your favor," he said.

Money managers say risks of using oil proxies often are justified by avoiding the high cost of betting on futures.

Investors buying dollar-denominated foreign bonds have been rewarded in recent years, as a rising U.S. currency helped bolster returns over debt issued in the local currency. Some investors believe that Norway can use its $850 billion sovereign-wealth fund to stave off any oil-related hits to its economy, which they say has helped the krone outperform crude prices in the past two months. Petrobras's bonds may have been spared from bigger losses because some investors believe that Brazil won't allow the company to go under, even if oil prices fall further.

Meanwhile, many crude proxies already have notched big declines, suggesting a limit to future downside moves, they say. The Mexican peso, for instance, is down more than 32% since May 2011. Petrobras bonds have fallen by about 23% since December 2014.

Wasif Latif, who helps manage about $27 billion at USAA Investments, is buying the stocks of oil producers such as ConocoPhillips and Cimarex Energy Co., which have been hurt during the decline in crude prices. Cimarex's shares have fallen nearly 20% this year. ConocoPhillips's stock price is off by 33%.

"Oil can go down further, and trading in these stocks may still be choppy," Mr. Latif said. "But from a valuation perspective they are very attractive."

(END) Dow Jones Newswires

December 22, 2015 19:05 ET (00:05 GMT)

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