The Commodity Futures Trading Commission (CFTC) recently issued an interim report by CFTC Staff on the April 2020 price collapse of the West Texas Intermediate light sweet crude oil futures contract (WTI Futures Contract). Since May, CFTC Staff has been reviewing the $55 per barrel plunge in the WTI Futures Contract, which resulted in not only the lowest settlement price since trading began 37 years ago, but the first negative settlement price. Though this report may be better than nothing at all, at present, the CFTC has provided little guidance and comfort to those actively trading regulated crude oil derivatives or those impacted adversely by the April price crash. The CFTC Staff has not indicated when it will issue a final report.
Prior to the expiration of futures contracts, market participants who do not intend to make or take delivery of the crude oil underlying the futures contracts seek to close out their positions.
On April 20, 2020, the price collapsed for the May 2020 WTI Futures Contracts. The level of trading to achieve compression—i.e., the process of reducing the total number of futures contracts that remain open without an offsetting position or fulfilled by delivery through trading or netting—was historically high, resulting in the price for open May contracts dropping throughout the day. The May contracts, set to expire on April 21, opened the trading day at nearly $18 per barrel and eventually bottomed out at -$40.32 per barrel before settling at -$37.63. Much of the decline occurred in a 21-minute window at the end of the US trading day. Traded 24 hours a day from Sunday to Friday, prices recovered positive value later that evening, and though they again dipped below $0, prices recovered the next day to $10.01 per barrel. WTI Futures Contracts have remained above $0 since, having recovered more than half of the pre-coronavirus (COVID-19) pandemic price.
CFTC Staff’s Initial Findings
The CFTC Staff’s initial findings attributed several causes to the negative settlement price that was reached in April 2020, identifying three “fundamental factors.” First, the CFTC found that an “already oversupplied global crude oil market” buckled due to an “unprecedented reduction in demand” after the onset of the COVID-19 pandemic and the subsequent quarantines, travel restrictions, and shutdown orders. Second, the market had concerns whether OPEC or other major global producers could respond quickly to the significant demand reduction. CFTC noted that these concerns “were particularly pressing at the Cushing, Oklahoma, oil terminal, which serves as the delivery point for the physically-settled WTI Contract.” And third, by March 2020, the working available storage at the Cushing facility was near capacity. In short, the Staff’s initial assessment attributes the price collapse to a confluence of high production, low demand, and a lack of storage capacity.
In addition, the CFTC identified several “technical factors” that “coincided with, and may have influenced,” the negative settlement price. These included an unusually high number of open May contracts; that most traders holding May WTI Futures Contracts had traded out of their positions before April 20, though on April 20 the number of remaining holders was consistent with prior months; a decrease in liquidity in the May contracts “well before April 20”; and a price move so rapid as to counteract the exchange-based control mechanisms designed to impose pauses in trading during rapid movements.
Commissioners Rostin Behnam and Dan Berkovitz both issued public remarks on the Staff’s interim report. Commissioner Behnam offered praise for the report and indicated that the report raises “serious questions regarding the Commission’s existing policy and recent rulemaking efforts” on position limits. Commissioner Behnam also suggested that the report supported his dissenting opinion last December to the Electronic Trading Risk Principles proposal, arguing that the CFTC must review these principles in light of the April 20 events.
Commissioner Berkovitz, in contract, issued a scathing rebuke of the interim report:
“[T]he issuance of an incomplete preliminary Report is a disservice to the public, market participants, and small and large businesses that depend on a reliable crude oil futures benchmark for contract pricing, risk mitigation, and price discovery.” Commissioner Berkovitz contended that the report, rather than determining the root causes and providing an adequate explanation, “provides a general recitation of economic conditions in the weeks and days leading up to April 20, and offers only aggregated statistics regarding trading on that day.” He argues the report identified a “limited scope of factors [without] any analysis of the effect of those and other factors.”
Commissioner Berkovitz also identified specific omissions and deficiencies. First, he chided the Staff for a failure to analyze the extreme divergence between the WTI Futures Contracts and the price of physical oil. Second, he argued that the Staff performed an insufficient analysis of storage availability at Cushing, Oklahoma, and the existing discussion relied on “anecdotal reports” but lacked actual analysis. Third, he cited a failure to examine the “very large number of [trade at settlement] contracts,” noting that the CFTC has brought two enforcement cases, though many years ago, related to trade at settlement contracts being used to manipulate the price of future contracts. Finally, he questioned the terse analysis of the 20-minute window in which the majority of the price collapse occurred, noting that the same “fundamental factors” that caused the crash on April 20 also existed on April 21 when prices recovered. He suggested that the Staff investigate whether some other unidentified factor bore responsibility for the sharp drop. Commissioner Berkovitz then urged the Commission to provide a “complete and accurate” report as soon as possible.
The report title suggests that the CFTC Staff will issue a subsequent final report. The Staff, however, has not indicated when it will complete its analysis. Considering the serious concerns raised by Commissioner Berkovitz, who some consider a frontrunner for CFTC chairman in a Biden administration, the CFTC Staff will likely address his specific concerns.
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