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Life after negative oil prices - Barış Sanlı

Negative oil price was not a surprise to some. The event itself is historical, but the missing analysis in the aftermath of this historic event is the developments may initiate. In this comment, a brief impact assessment of this historic event will be explored.

We know for sure that some regional oil prices have dropped below zero before 20th April. Therefore having a zero oil price is not the historic event by itself. What can be deemed historic has two parts. Firstly, a benchmark oil price has dropped below zero. The second one is the magnitude of the negative price was enormous.

The financial aspect is prominent. However, the role of manipulation, algorithms, and rules are not that obvious. It will take time to unfold the details. The causality of the event should be understood correctly. Sometimes investors jump into such funds as if a small opportunity window has opened for a limited time. In Turkey, for example, we are hearing rumors that people are betting that this can be the lowest oil price ever and taking long positions. One danger is the possibility of another negative price and margin calls. As CEO of CMEGroup states, in the futures market, they may be unlimited losses. Do not think that you are as clever as Mexico in oil hedging, as Pierre Andurand underlines, “it is a dangerous game now.”

WTI as a benchmark has the effect of triggering multiple events in other oil prices. There are at least dozens of oil pricing regimes based on WTI. Until 20th April, no one thought that oil prices could be negative. But all WTI-based contracts and oil blends have the risk of seeing negative prices. All risk assessments have been changed.

The fear of negative prices has dried up liquidity in the futures market. A more liquid futures market was the guaranteer of healthy price discovery. Now price discovery (not forecast) will be more costly and more shallow. This may create further volatility.

The other important discussion is about the “benchmark” discussion. There are several ways forward. The WTI benchmark may change assessment or may add further assessment procedures. The recently discussed one is about Houston delivery. The landlocked version of WTI is not the right tool for a massive producer like the US, maybe. It is for sure that Cushing is an excellent point for storage and pricing a WTI of US, but an international WTI needs updates.

There is also the bloodbath. Starting from small investors, there are losses spread across the world. Most retail investors look as if they were unaware of the physical delivery settlement. Interactive Brokers has posted USD 88 million provisional losses. Compared to open contracts, this may look like a big loss.

According to WSJ, oil-linked products caused Chinese investors to lose about USD1.3 billion. The promised “bao”(treasure) of crude oil products has left lots fo small investors with losses they may not have imagined.

For the CME Group, their negative pricing has also caused international concerns. Reuters has published a story about Bank of China’s request from CME Group to investigate ‘abnormal fluctuations.

Shale oil producers are no different. Harold Hamm of Continental Resources has sent a letter to Commodity Futures Trading Commission (CFTC) to investigate “possible market manipulation, failed systems or computer programming failures” on the CME. Therefore China and some shale producers are at least on the same page when it comes to oil market dynamics.

The crises have the habit of slowly revealing their full impact. A negative price is a surprising event and a headline maker. However, it is just a trigger. Without creating more mystery, I would like to speculate on what may happen.

WTI as a benchmark is likely to evolve; the early signs have started from CME. WTI Houston Crude Oil Futures is a likely candidate. This will change a landlocked WTI to a waterborne one. The carnage of negative prices will pressure the CME Group on pricing rules. We expect more statements from CME to mitigate liquidity drain and fear of negative prices. The banking sector is probably shocked by the negative prices, and crude oil products will be impacted. The Mexican hedge will be more costly. Hedging itself turns a more risky business than fundamental market forces. But 20th April is only the start of such an event. Another wave of benchmark discussion may be waiting for us.


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