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Rise of Oil, Gas Hedge Funds Cited in Volatility of U.S. Energy Prices

Posted on: Wednesday, 1 March 2006, 06:00 CST

By Paul Monies, The Daily Oklahoman

Mar. 1--The rise of hedge funds investing in oil and gas stocks has contributed to swings in energy prices, a Merrill Lynch analyst said Tuesday in Oklahoma City.

John Herrlin Jr. likened the buzz surrounding energy stocks to the fever over dot-com stocks in the late 1990s. While institutional holders own the majority of outstanding energy company shares, hedge funds and other noncommercial players are among the most active traders, he said.

Geopolitical uncertainty and supply issues remain the largest predictors of energy prices, but speculative traders have added to the volatility, he said. Hedge funds manage about $300 billion in energy company stocks.

"The futures market has added a speculative flavor," Herrlin said. "It's a commodity-based stock group where people are betting on destruction."

Herrlin, who follows about $900 billion worth of energy companies for Merrill Lynch, spoke to clients and investors at a breakfast presentation at Gaillardia Golf and Country Club. The former geologist has been an analyst since 1994.

His long-term forecast, which he places beyond two years, calls for oil prices to be around $42 a barrel and natural gas at $6 per thousand cubic feet.

While the natural gas market fluctuates depending on the weather and domestic drilling, the oil market is dominated by geopolitical events. Herrlin said oil is "politically unfriendly" to the United States, citing examples of U.S. companies being expelled from Saudi Arabia in the 1970s, re-opening Libyan markets after terrorism-related sanctions and political unrest in Venezuela.

"(President Hugo) Chavez is just Castro with money, which is not a good thing," Herrlin quipped.

Mergers and acquisitions in the energy sector have overshadowed the lack of growth in proved reserves, he said. Since the early 1990s, there have been 558 merger and acquisitions deals that totaled $807 billion.

"We believe that the industry has over-consolidated and that higher prices are a consequence," Herrlin wrote in one presentation slide. "That should cause another exploration cycle, which onshore will be led by the independents."

Herrlin also warned about the coming "geriatrification" of the employee base in the energy sector. Baby boomers soon will start retiring in large numbers from the industry, but companies aren't doing enough to train and find their replacements.

"This is a business of gray hair and no hair," he said. "It takes years to understand what's going on in a basin. That's one reason we'll see higher prices."

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Source: The Daily Oklahoman

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