Do you remember the 20th of April? (a look at when oil price went negative)

If we look at the price of oil these days seems impossible to think that just a few months ago, on April 20^th  the price of the WTI benchmark went, for the first time in history, in negative territory.

After a few months it is not yet clear what exactly caused such a dramatic drop. The hypothesis are multiple, and range from the probable( a perfect storm of sudden collapse in demand and full storage at Cushing) to the outlandish (someone might have “cornered” the market)

The reality might be a bit more complex than the usual extreme interpretations, but one thing is sure: someone definitely made a lot of money out of this unprecedented market conditions.

And even more people have lost their shirt.

Now, I am not going to express my hypothesis on the matter, but I would like to draw a few considerations which stemmed from this, so far, unprecedented market condition.

The first is the obvious one: if the market fundamentals change suddenly and the expectations of operators are thrown into chaos, anything can happen. So, contrary to what many commentators did, I do not deem the negative price, in all its unusualness, a market failure. Rather than that, a proof that markets work. If all of a sudden storage become scarce and there is no outlet for an excess volume, it is very possible that the price of a good might go negative ie someone needs to be paid to take the stuff off your back.

That said, a few other point come to mind.

According to a Bloomberg article, an obscure oil trader based in London has pocketed a windfall of more than $500 million in the days around the settlement of the May WTI contract, which is when the price of the future turned negative (I will never underline this enough: it is the future price that went negative, the paper contract, not the price of the oil itself.).

How did they do it? They sold aggressively, and in unison, futures around the settlement date.

This has possibly, but not surely, exacerbated the dramatic fall (as a proof, the price rebounded from -20 to +10 USD in matter of a few hours after the crash). Maybe other bigger traders have also participated in the epic sale, making the impact even bigger.

However the case, seems obvious that where there are big winner, there are also big losers.

Who are this losers? The obvious answer would be frackers and producers in general.

However there seems to be an even bigger category: American and Chinese(mainly) retail investors, who piled in instruments pegged to the WTI. This fact brings the first consideration:if you are a retail investor, you better avoid investing in commodities, especially in times of high turbulence because, as in the sea, the big fish eats the small one, and a retail investor is by definition the small fish.

The second consideration is a bit more structural: with the yields so low and central banks continuing injecting liquidity in the markets, the hunt for returns has shifted risk appetite into high gear. That is a cause for concern especially because at a certain stage the liquidity will have to be drained back and also, increasing the risk appetite in subject who lacks the culture and the risk management instruments to take on riskier bet, is never going to end well, adding to the volatility and ultimately risking ruin for scores of operators. Also, volatility is good for traders, but not for consumers and producers. And excessive volatility is not good for anyone.

Another issue that should be seriously considered is regulation: Many believe that what happened on April 20^th was solely the result of market forces: the idea goes that that has not happened in the Brent future market(which operates quite differently tough and does not have one single point of delivery like Cushing). And hence calls for tougher regulation, as usual, ensue.

Now, in my view it is unlikely to manipulate a market as deep and liquid as the WTI. What might have happened is that nimble traders have jumped on a trend they were seeing, and made a killing: however the trend could as well have been reversed, and today no one would remember the obscure London trader who made 500 million in a day.On top of this, demonstrating the intent to corner a market is far from straightforward.

Which leads to the question: is regulations as it stands sufficient? In light of what happened, a case could be made to say no. However it is not really THAT clear what has happened. And there is an intrinsic case to be made for stable regulatory framework: no one likes playing in a game where the rules are changing constantly. And companies need stability.

Another more pragmatic approach would be to understand on whether limits on positions or certain “circuit breakers”, like in certain stock markets,  should be put in place to avoid such extreme swings, which might jeopardize large swaths of the market participants (just imagine being the CFO of an oil producing company on that day…and banks start to call about the value of your inventory posted as collateral).

So to conclude, I am tempted to think that more regulation is not needed, and that if anything a long hard look should be given at the way exchanges like the CME work.

And in the longer term, there is the need to understand whether allowing so much liquidity with such an ease on a vital market like WTI is such a good idea. And, more prosaically, A case could be made that the current market structure, with Cushing being such a bottleneck and a risk point both for physical and future markets, is definitely obsolete.