The 20 Minutes That Broke the U.S. Oil Market – Yahoo Canada Finance

The below-zero price scenario was, in some corners of the market, starting to be considered. On April 8, a Wednesday, CME Group Inc, which owns the oil-futures exchange, advised clients that it was “ready to handle the situation of negative underlying prices in major energy contracts.”

That weekend, producing nations led by Saudi Arabia and Russia finalized their response to the crisis: a deal to slash production by 9.7 million barrels a day, amounting to a tenth of global production. That wouldn’t be nearly enough. Refineries started shutting down. Buyers for cargoes of oil for immediate delivery in physical markets disappeared.

Futures prices remained, for a while, relatively steady.

That was in part thanks to folks like A’Xiang. In China, investors large and small were betting on higher commodity prices, believing the world would overcome the virus and that demand would bounce back. Bank of China branches posted ads on Wechat, showing an image of golden barrels of oil under the title “Crude oil is cheaper than water”.

Yet on April 15, CME offered clients the ability to test their systems to prepare for negativity. That’s when the market really woke up to the idea that this could actually happen, said Clay Davis, a principal at Verano Energy Trading LP in Houston.

“That’s when the dam broke,” he said.

Physical Delivery

By the time Monday April 20 rolled around, most ETFs and other investment products — though not the Crude Oil Treasure fund — had shifted their position out of the May WTI contract into the next month.

Futures contracts are settled by physical delivery, and if you happen to get stuck with one when it expires, you become the owner of 1,000 barrels of crude. Rarely does it come to that.

But now it was.

The physical settlement for the benchmark WTI takes place at Cushing, Oklahoma. When storage tanks there fill up, the price on the expiring contract can plunge and become disconnected from the global market. With demand evaporating, inventories at Cushing were soaring. In March and April, they climbed 60% to just under 60 million barrels, out of a total working capacity of 76 million –- and analysts reckon much of the remaining space is already earmarked.

So on the crucial Monday, the penultimate day of trading in the May WTI contract, there were precious few traders able or willing to take physical delivery.

Much of the market was focused then on the settlement price, determined at 2:30 p.m. in New York. Investment products –- including Bank of China’s –- typically seek to achieve the settlement price. That often involves so called trading-at-settlement contracts, which allow oil traders to buy or sell contracts ahead of time for whatever the settlement price happens to be.

No Buyers

On that afternoon, with trading volumes thin and sellers outnumbering buyers, the trading-at-settlement contracts quickly moved to the maximum discount allowed, of 10 cents per barrel. For a period of around an hour, from 1:12 p.m. until 2:17 p.m., trading in these contracts all but dried up. There were no buyers.

The result was the carnage of that afternoon. At 2:08 p.m., WTI turned negative. And then, minutes later, sank to as low as minus $40.32 before rebounding slightly at the close.

“The trading at settlement mechanism failed,” said David Greenberg, president of Sterling Commodities and a former member of the board at Nymex. “It shows the fragility of the WTI market, which is not as big as people think.”

Prices in the U.S. physical market, set by reference to the WTI settlement, also plunged, with some refiners and pipeline companies posting prices to their suppliers as low as minus $54 a barrel.

Bank of China’s investment product offers an explanation of why the move below zero was so dangerous. The bank had demanded investors like A’Xiang put up the entire cost of what they were buying in advance. That meant the bank’s position looked risk-free.

But not if prices dropped below zero: then there wouldn’t be enough money in the investors’ accounts to cover the losses.

The bank had a total position of about 1.4 million barrels of oil, or 1,400 contracts, according to a person familiar with the matter. It wound up having to pay about 400 million yuan ($56 million) to settle the contracts.

Across the investing world, others were faced with similar risks. ETFs could be bankrupted if the price of the contracts they held went below zero. Facing that possibility, they shifted a large chunk of holdings into later delivery months. Some brokers barred clients from opening new positions in the June contract.

The moves amounted to a new wave of selling that swept across oil markets. On Tuesday, the June WTI contract plunged by 68% to a low of just $6.50. And this time it was not limited to U.S. contracts: Brent futures also plunged, hitting a 20-year low of $15.98 on Wednesday, driving the price of Russian, Middle Eastern and West African oil that is priced relative to it to levels near zero.

CFTC’s Top Priority

Harold Hamm, chairman of Continental Resources Inc., called for an investigation, saying that the dramatic plunge in the last minutes of Monday “strongly raises the suspicion of market manipulation or a flawed new computer model.”

Within the Commodity Futures Trading Commission, unpacking what occurred during those final minutes of trading on April 20 has since become top priority, according to people familiar with the matter. While reviews and investigations into what occurred are just beginning, thus far, top officials believe the moves were likely the result of a confluence of economic and market factors, rather than the result of market manipulation.

An issue the CFTC is exploring is whether the storage capacity data posted by the U.S. Energy Information Administration accurately reflected the actual availability of space, two of the people said.

“The temporarily negative price at which the WTI Crude futures contract traded earlier this week appears to be rooted in fundamental supply and demand challenges alongside the particular features of that futures product,” CFTC Chairman Heath Tarbert told Bloomberg News.

Nonetheless, he added: “CFTC is conducting a deep dive to understand why the WTI price moved with the velocity and magnitude observed, and we will continue to oversee our markets’ role in facilitating convergence between spot and futures prices at expiration.”

The CME, for its part, argues that Monday’s plunge was a demonstration of the market working efficiently. “The markets worked exactly how they’re supposed to do,” CEO Terry Duffy told CNBC. “If Hamm or any other commercials believe that the price should be above zero, why would they have not stood in there and taken every single barrel of oil if it was worth something more? The true answer is it wasn’t at that given moment in time.”

Whoever is right, the events of the week have changed the oil market forever.

“We witnessed history,” said Tamas Varga, an analyst at brokerage PVM. “For the sake of oil-market stability,” this “should not be allowed to happen again.”

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