Barclays' barrier digital notes tied to oil may appeal to investors expecting sideways market

By Emma Trincal

New York, March 14 - Barclays Bank plc's 0% contingent buffer enhanced notes due March 26, 2014 linked to Brent crude oil may offer an alternative to a direct commodity play for investors who lack strong convictions about oil as either bulls or bears, sources said.

If the final price of Brent crude oil is greater than or equal to the barrier level, the payout at maturity will be par plus 10.2%. The barrier level will be 85% of the initial price, according to an FWP filing with the Securities and Exchange Commission.

If the final price is less than the barrier level, investors will be fully exposed to the decline from the initial level.

"It's a range-betting strategy," a market participant said.

"I don't know how it's priced, but it's designed for the mildly bullish or mildly bearish investor."

Favorable positioning

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that he liked the risk/reward associated with the investment.

"I'm optimistic that Brent crude will increase within the next 12 months," he said.

"The notes are designed for someone with a range-bound view, but the range outlined by the structure provides a very favorable positioning.

"You have 15% protection on the downside and a possible 10% return on the upside. I think it's a fair range.

"I know that oil as an asset class is very volatile. However, I like the opportunity for the next 12 months relative to this range.

"If it was a five-year note, it would be a different story."

Brent oil prices are down almost 4% so far this year despite signs of a U.S. economic recovery. Prices have oscillated between an $89 low in June 2012 and a $127 high a year ago. Brent crude oil is currently trading at $109 a barrel, just at mid-point.

Fundamental outlook

Michael Haigh, global head of commodities research at Societe Generale, told Prospect News that his fundamental view on Brent crude oil is "range bound," which would "match out" the underlying theme of the notes, but he declined to comment on the product or its pricing.

"We are not bearish on [Brent crude oil]. Our outlook is pretty range bound but with more upside risk than downside risk."

He predicted a 5.5% increase from today's price to "roughly" $115 a year from now.

"Our fundamental view is not bearish, but it's not truly bullish," he said.

The bullish outlook, albeit moderate, comes from a number of factors.

"There's a robust demand," he said.

"The Saudis are cutting back on production to support prices. They control supply to keep it very tight. They need $100 per barrel to cover their own budget. It's a floor. They do have the power to cut back on production. Last year they cut back 1 million barrels a day.

"Secondly, we see a moderate growth in the economy and a sustained demand, particularly from emerging markets.

"This leads to a more bullish conclusion than bearish."

In addition, Brent oil prices can be affected by geopolitical events, he noted.

"You have renewed chatter between Iran and Israel. You can't really tell when something may happen. The timing of events in geopolitics is always uncertain. But it's bubbling away in the background," he said.

On the other hand, Haigh said that other factors limit the bullish outlook.

"We're not overly bullish because again, the Saudis control supply and they don't want Brent oil to go up a lot. When the cost of energy as a percentage of income becomes prohibitive and chokes off the customer, you get a recession and global demand deteriorates. The direct result is demand destruction, and the Saudis are not interested in that. OPEC has the ability to ramp up, which they will do if they have to.

"So fundamentally we have a range-bound view," he said.

Unpredictable

Steve Doucette, financial adviser at Proctor Financial, said that he did not find the structure appealing given the volatility of the underlying.

"You have 100% exposure on the downside," he said.

"On this one, you shoot for a 10% return on a very volatile asset class.

"You hope that oil will go back up but not by too much or that it won't drop by more than 15%.

"Your risk/return is not very attractive. All you can make is 10%, but you can lose 100%.

"If it was a little less volatile asset class, it may be a way to replace some type of bond allocation in your portfolio to get some coupon. But because it's so volatile, I don't like the risk/return characteristic of this note.

"When people talk about oil, they say that it's going to go through the roof and then it drops shortly after that. It's very unpredictable."

He also noted the supply factor, with the growth of shale gas production.

"We are starting to use a lot more natural gas. It's so much cheaper. People are starting to convert from oil to gas," he said.

Barclays is the underwriter, with JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC as dealers.

The notes are expected to price on Friday and settle March 20.

The Cusip number is 06741TQZ3.

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