Oil has made false starts in Januaries past

By Jonathan Leff

SINGAPORE (Reuters) - Oil's roaring start to 2008 is not necessarily an indication of price movements for the year to come if the evidence of the past two years is any gauge.

A big difference in 2008 compared with the last two Januaries is that oil has reverted to its classical market structure, in which prompt contracts are more expensive than those for later delivery. This could encourage investment funds to stay in oil.

Prices surged nearly 4 percent to touch a record $100 a barrel on Wednesday, the first trading day of 2008, driven not only by tightening U.S. oil supplies and geopolitical jitters but by the allocation of more fund capital into commodities.

"With the new calendar year it's time to refresh the books and reallocate," said Steve Rowles, an analyst at CFC Seymour in Hong Kong. "And with risk aversion increasing, commodities seem to be seen as a safe haven right now."

Pension funds and other long-term investors have pumped an estimated more than $100 billion into commodities over the past five years, often using long-only passive indices like the S&P GSCI that require investors to buy and hold positions.

Their quarterly approach to shifting money between financial assets barely makes waves in huge trillion-dollar markets like U.S. equities or fixed-income, but can quickly roil oil, where the value of total open interest in New York Mercantile Exchange crude oil contracts comes to below $140 billion.

Even at $100, investors' appetites appear little diminished.

"We still have our maximum quota on oil and we don't see any reason to lighten up our position at all, since all the risks are still to the upside," said Justin Wilks, who helps manage Global Commodities, an Australian index-based fund of around $250 million, one of the few pure resource funds in Asia.

This year's events struck a familiar seasonal chord with traders who recalled the run-up from below $60 to nearly $70 a barrel in the first few weeks of 2006, when a dearth of news put a spotlight on the impact of fund allocations.

And few will forget the disappointment that greeted 2007, when prices dived more than $10 to below $50 as speculators who had hoped for a repeat of the fund frenzy bailed out.

In both cases the momentum move proved short-lived -- by mid-February prices had reverted to pre-new year levels.

FALSE SIGNALS

Both gave false signals for the year ahead -- after 2006's rip-roaring start, oil prices managed a gain of only 1 cent; in 2007 prices closed the year almost $35 higher.

The erosion of gains in 2006 coincided with the persistence of an atypical oil market structure, known as contango, when prompt prices are discounted to future oil prices. This wipes out returns that funds can make from rolling positions in prompt contracts into those for later delivery.

But last July, the oil market reverted to its more characteristic backwardated structure, in which prompt prices are the most expensive.