June 10, 2016 9:00 AM, EDT

Some Hedge Funds Are Betting Oil Will Surge Above $100

Susana Gonzalez/Bloomberg News
Oil investors are buying contracts that will only pay out if crude rises well above $100 a barrel over the next four years — a clear sign some believe today’s bust is sowing the seeds of the next boom.

The options deals, which brokers said bear the hallmarks of trades made by hedge funds, appear to be based on the belief that current low prices will generate a supply crunch as oil companies cut billions of dollars in spending on developing fields. The International Energy Agency forecasts that non-OPEC supply will suffer its biggest decline in more than two decades this year.

"The market faces a supply crunch in the next 24 months," said Francisco Blanch, head of commodities research at Bank of America Merrill Lynch in New York. "Some hedge funds are betting that oil prices will need to rise sharply to bring demand down again — that’s why they are buying deep out-of-the-money call options."

Over the past month, investors have bought call options — giving the right to buy at a predetermined price and time — for late 2018, 2019 and 2020 at strike prices of $80, $100 and $110 a barrel, according to data from the New York Mercantile Exchange and the U.S. Depository Trust & Clearing Corp.

Even before the most recent flurry, some investors had built super-bullish positions. The largest number of outstanding contracts — or open interest — across bullish and bearish options contracts for December 2018 is for calls at $125 a barrel. For December 2020, it’s for $150 calls.

Earlier this month, one investor bought more than 4 million barrels worth of call options at $110 and $80 a barrel for 2019 and 2020 in several transactions. An additional 800,000 barrels worth of $60-a-barrel call also changed hands. The deals are public because of new regulations introduced in the United States by the Dodd-Frank Act. The disclosures don’t reveal the final buyer.

Funds making the trades aren’t necessarily expecting prices to jump as high as $100 to $150 a barrel, as the value of their call options will increase even if prices rise far less. These kind of options speculators are buying often are seen as lottery tickets because they offer an outside chance of very large returns.

The options deals suggest sentiment is starting to shift from worry about oversupply to concern about shortages as demand begins to outstrip production — the traditional boom-and-bust commodities cycle.

"Large spending cuts on the back of low oil prices will lead to the demand and supply gap widening from 2018 onwards, if not earlier," said Abhishek Deshpande, oil analyst at Natixis SA in London. "This is likely to push oil prices up as early as 2017."

There also are reasons to be skeptical that this year’s rally from less than $30 in January to more than $50 today will be sustained. Production outages in Canada and elsewhere probably will prove temporary, U.S. shale producers may bring fields back online as prices rise and global stockpiles remain well above historical averages.

Last year, some investors took the opposite bet, buying large amounts of bearish put options that would only pay if prices plunged below $30 a barrel. When West Texas Intermediate oil briefly fell in February to a 12-year low of $26.05 a barrel, the value of those options surged and speculators cashed in.