Extreme times can make future markets turn strange

Many of us watched in amazement April 20 as the nearby West Texas Intermediate crude oil futures fell past zero and cratered at $-40 per barrel.

The collapse happened with lightning speed, and as fast as I refreshed my chart I couldn’t keep up with the collapse. It was stunning.

I wasn’t the only one that day glued to the charts.

“The world’s never seen that before,” said Glen Hallick, an experienced markets reporter with Glacier MarketsFarm, as I chatted with him on April 21st for our podcast, Between the Rows.

On April 24, broker and analyst Errol Anderson of ProMarket was still amazed by what he had seen.

“It took your breath away,” he told me at the end of another crazy week in the COVID-19 markets.

For those of us who spend much of our lives following markets, like Hallick and I, the implosion in oil futures was a stunning, frightening and fascinating event to witness.

For those like Errol, who spend their lives trading those markets, it was fascinating and an educational exercise in how markets can operate when they are pushed into circumstances nobody imagined.

“There was an extreme exchange of money,” said Anderson.

“The speculators in the market really got caught in something they weren’t expecting.”

Imagine that: having to pay somebody $40 to take a barrel of WTI oil. If you had taken a long position for a few thousand barrels in the expiring contract, you’d have needed to be a rich man to avoid financial catastrophe.

The oil collapse was very much a futures market phenomenon. Actual liquid oil traded for a few dollars above zero that day in most places. But what happened on April 20 reveals the freaky things that can happen in extreme circumstances. The usual assumptions don’t apply. The physical and futures markets can separate radically (Brent crude oil didn’t experience this situation), and also be much more closely tied that you would expect.

Here, the WTI cascade into massively negative territory came as longs tried to roll out of the expiring contract and into the June contract. The problem was that there were no buyers.

Many contracts today are “cash settled,” which means they are based off a cash market index and while cash is exchanged by expiry if positions are still open, there is no chance you’ll actually end up owning a bunch of a commodity in storage. That’s how Brent crude trades.

That isn’t true with WTI, which still has a “delivery” component, which means somebody can refuse to close a position and instead receives possession of or can deliver a commodity to a storage facility somewhere. For WTI, that’s Cushing, Oklahoma. And it’s running out of storage capacity. That provoked this implosion.

Usually the threat of delivery disciplines futures prices and ensures cash and futures prices don’t significantly diverge. But here, a problem in the storage structure in one part of the physical world led to a shocking phenomenon in the futures world.

It’s worth learning from situations like this because in the tortured coronavirus reality it isn’t likely to be the last one.

“It puts a warning out to the whole commodity complex,” Errol said.

“If crude oil, which is the king of the commodities, can do this, why can’t everything else?”

Indeed, nothing is assured these days. This is like the borderland between the universe governed by the laws of relativity and that governed by quantum mechanics. Stuff that shouldn’t be possible, suddenly is. Two sets of laws that don’t seem to apply to each other start shooting out sparks where they touch.

That’s where we’re at in futures, commodity markets and society. Little is predictable.

“We’re going to see other weirdisms over the next year,” Errol said.

How weird are things going to get? Stay tuned.

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