Negative Oil: CFTC warns it could happen all over again

In April 2020, a day prior to the WTI Futures settlement, the price of WTI crude May futures dipped all the way to ($-37.63/bbl).

May 15, 2020 9:57 IST | India Infoline News Service
In a terse advisory to all the brokers and clearing houses, the Commodity Futures Trading Commission (CFTC) warned that WTI Crude could go into negative all over again in the month of May. In April 2020, a day prior to the WTI Futures settlement,  the price of WTI crude May futures dipped all the way to ($-37.63/bbl). That had led to substantial chaos in the US and even in markets like MCX, where the contract is benchmarked to WTI.

WTI Crude Price Movement over last 6 months

Chart Source: Bloomberg

The CFTC advisory clearly states that the macro build-up exists for another crude oil crash into negative territory and CFTC is clearly worried as the June WTI contracts are due for expiry on May 19th. Let us look at why WTI crude crashed into negative in April and the probability of it happening all over again.

Four reasons why WTI crude dipped into negative in April 2020

On April 20, the penultimate day of the May 2020 WTI Crude contracts, the crude price closed at ($-37.63/bbl) for the first time in its entire history. Negative prices means someone with a long position in oil would have to pay someone to take that oil off of their hands. There are four reasons why this happened. 
  • One reason for the negative crude prices on April 20 was the inverse of a short squeeze. On April  20, 2020, traders with long crude oil futures scrambled to get out of their positions amid fears that it would be tough to find a place to park physical oil. It was sheer desperation to exit long oil contracts.
  • Secondly, there was the contango factor. This is normal when the current contract moves to expiration and the demand shift to next month. In the above case, June contract was at a steep premium to spot oil and also to May WTI contract. This normally happens when long positions are being rolled over.
  • Storage had been running tight for some time and it only go tighter. Data was showing historic jump in US inventories in Cushing, Oklahoma, the delivery hub for NYMEX futures. Nobody wanted to own May delivery futures when storage was scarce, forcing traders to dump long WTI crude positions.
  • Finally, nobody cared about gasoline prices any longer as most of the US was under lockdown to contain the pandemic. With too much supply, limited inventory storage and weak demand; crude longs were a baby nobody wanted to hold.
CFTC is worried about a repeat of negative crude prices

The WTI Crude June contract is slated to expire on Tuesday, 19th May. The CFTC, which is the nodal regulator for trading in futures and options in the US, wants to avoid a repeat of the previous month situation. However, the situation appears to be less serious this time around and that could reduce the possibility of negative crude all over again. Here is why.
  • Brokers have started to play the game more safely. Interactive Brokers took a hit of $105 million and is monitoring crude positions very closely. Another broker, GH Financials has already asked all its clients to exit near-month oil contracts at least 5 days before expiry. That means; most of the oil positions there are already closed out.
  • The regulators are also monitoring at multiple levels. The CME, which handles trading and clearing of WTI futures contracts, as well as the CFTC are monitoring open positions closely. Even in April, CME had warned about the distinct possibility of negative oil. This time around, nobody is likely to take chances with crude contracts.
  • The storage situation has substantially improved in the last one month. Inventories at Cushing, Oklahoma are down by 3 million barrels to 62.4 million bbl. That leaves a space of about 14 million barrels still. So the June settlement on May 19th is unlikely to be as stressed as the previous contract.
What does that mean for MCX Crude contracts?

The good news seems to be that, despite the CFTC advisory, the situation does not appear to be as volatile as the previous month. Brokers, traders, clearing houses and exchanges are better prepared for an eventuality and that reduces its probability. MCX has already permitted negative prices for crude in its system as well as an exit route for traders in the event of negative commodity prices. With commodity markets globally better prepared for negative prices, it is less likely to happen this year. But traders in crude in India as well as the exchanges and clearing corporations would do well to insist on stringent margining and risk management.

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