Falling Crude Putting Hedge Funds Over a Barrel?

When the price of natural gas plummeted last Summer, hedge fund Amaranth took a nose dive. Now some investors are worried the same could happen with hedge funds that invested heavily in oil. "In the short term, market sentiment is overwhelmingly bearish and it's possible for (the) price to go lower than $50 (a barrel),” said Victor Shum, an analyst with Purvin & Gertz. On today’s "Morning Call," Mary Thompson looked into whether the steep declines in crude could trigger a hedge fund implosion.

AS CNBC has been telling you, crude futureshave slipped for eight of the first 12 trading sessions of 2007, partly on mild winter temperatures in the U.S. Northeast and growing fuel stockpiles.

“There have been persistent rumors over the last few of weeks of hedge funds or one big hedge fund in distress (because of weakness in oil) and we have found one of them,” explained The Wall Street Journal's Ann Davis. Boone Pickens hedge fund BP Capital has fallen 6% the first two weeks of this year."

Peter Beutel, the president of the energy risk management firm Cameron Hanover, pointed out that it’s probably not only Boone Pickens experiencing pain. The environment is ripe for trouble. “If you look at the open interest, which is the number of outstanding contracts held overnight, we have seen prices drop as open interest has risen. Now we know a lot of people were holding long positions at the end of the year. So as prices drop we should have seen liquidation drop. Instead we’ve sent he opposite.” (In other words, some investors are still holding positions from the end of the year, when oil was much higher)

Although investors like Pickens might be down, they are, by no means, out. "I caught up with him earlier this week...he is still bullish on oil," said Ann Davis. “[And Pickens] has shown the ability to also make money on other declines in other energy markets. Last year his short bet on the natural gas markets compensated for losses in oil.”

What's the lesson here? “ Energy markets are volatile and they’re getting more volatile," concluded Davis. "Terrific returns you hear about at some hedge funds of over 100% can be warning signs that (returns) could swing just as widely in the other direction."