In case you’ve been quarantining under a rock, you’ll have seen that oil is having a crazy week. To make sense of it all, we sat down with Jordan, our head of trading and risk, to talk about what exactly happened to oil, what you should know about oil trading at BUX X and why we removed the multiplier.
Oil went negative for the first time ever. What happened?
On Monday, as we approached expiry for WTI (West Texas Intermediate Oil, the main oil benchmark for North America), the prices began falling rapidly to $0. Amazingly, after hitting rock bottom, it broke through that level and officially settled for May 20 expiry at -$37.63. No, that’s not a typo, that’s a negative value. I have never seen an oil futures contract expire on a negative basis before and that’s in a 25-year trading career!
And what are the reasons for that?
There are many catalysts, but here is my viewpoint: just previous to this situation, around one week before expiry, we were in a super contango market in oil. A contango is when the front-month future price trades lower than the second-month futures price.
This is completely typical, however, what isn’t typical is the size of the contango. At this time there was about an $8 difference between the front and second futures months – that’s a huge difference. The largest record of this prior to the event we’re seeing today was $17 which was recorded also on expiry in 2008.
The reason there was a large contango, which I’ll refer to as a hyper contango, was because there is a huge supply of oil for immediate delivery which currently cannot be used. Here’s where COVID-19 comes into play.
You mean people are using less oil because the whole world slowed down?
Yes. Never on a global scale have we been forced into isolation and confined to our homes. People aren’t flying or driving, so the demand is just not there, but there is more to it: the OPEC cartel that did not agree on any substantial output cuts at the most recent meeting. This was mainly due to a fallout between Russia and Saudi Arabia.
Finally, the type of oil (WTI to be specific) plays a factor. This is mainly stored and refined in Cushing, Oklahoma, located smack in the center of the US. Its location is landlocked, unlike Brent Oil, which is usually transferred by sea in large quantities from Scotland to other international ports. At Cushing, if the storage tanks are relatively full, which they are, then there isn’t that immediate option in the short term. The culmination of this is a perfect storm leaving sellers in a position where they will pay the buyer to take it off them.
But why is that? Why can’t we just store oil in the shed?
Well, the first reason is alluded to above. It’s tricky (a huge understatement) to arrange delivery of physical oil from Cushing, Oklahoma. That’s also assuming you can charter an oil tanker to move it to Europe, incidentally where daily storage rates have tripled over the past two weeks. But assuming you can get it here, you then have to find somewhere to store it (not the shed). The actual storage of oil is extremely hazardous! Not only is it toxic, but also unstable.
What happens to long and short positions on futures that expire?
With regards to BUX X long positions over expiry, you can only ever lose your initial investment amount. Looking at what happened on Monday, even though the official settlement was -$37.63, your US Oil 20 Apr 20 position was closed at $0. It’s not all bad, though! Had you been short on oil going into expiry you would have been given the full whack and settled at -$37.63. Take that!
Why did BUX X decide not to allow a multiplier on oil futures?
First of all, safe trading is important to us, and given the situation, we believe that offering leverage on US oil is currently not sustainable. Therefore, we removed the multiplier for the time being.
Additionally, we have removed it due to our internal risk limit. If people trade with leverage, the total value of the position is significantly larger. This also means that if many people open positions in oil, our exposure to that product can grow very rapidly. However, with the current volatility, our risk model doesn’t allow us to have a lot of exposure. Finally, our system cannot execute trades at a negative price because this practically never happens. Therefore, executions will then happen at a price of zero and we will then subsequently need to make certain manual adjustments to correct for this negative value.
When will the multiplier be back?
We can only put it back when the volatility is back to normal levels and when we think it is safe enough to trade with leverage again. We’re keeping a close eye on oil and dependent on the developments in the market, it could even be the case that we have to disable oil temporarily on our platform. However, we will do our utmost best to keep oil available and keep you updated as much as possible!