Owing to restrictions within the U.S. and abroad during the COVID-19 pandemic, the demand for refined petroleum products has all but disappeared. As a result, oil refineries have significantly cut their production and purchase of crude oil. This change in market demand created a dynamic where there were too many sellers and limited buyers.
The price of WTI crude oil has been steadily declining since the beginning of the year, having gone from US$60 per barrel to just under US$18 per barrel before yesterday’s flash crash, a decline of ~70%.
On Tuesday the 21st of April, the price of the Western Texas Intermediate (WTI) Crude Oil May futures (ticker symbol: CLK2020) dropped below US$0 per barrel, and reached a low of US$-40.32 / barrel.
One-minute chart of CLK2020 during the crash
- 00:00 (UTC) 20/4 – CLK2020 opens the day trading at US$17.07 / barrel
- 16:00 (UTC) 20/4 – CLK2020 is trading at US$10.33 and closes the hourly candle at US$4.90
- 18:08 (UTC) 20/4 – CLK2020 crosses below US$0
- 18:29 (UTC) 20/4 – CLK2020 bottoms at US$-40.32
- 00:04 (UTC) 21/04 -CLK2020 crosses back above US$0
The flash crash of the CLK2020 futures contract was a result of the contract expiring the next day. The WTI crude oil futures (CL) contracts are physically delivered, meaning that at the expiry of the contract, the holders of the contracts have to take physical delivery of the underlying asset, in this case, crude oil.
Since the end of February, stockpiles of crude oil at Cushing in Oklahoma, the main storage hub and delivery point for the CL contract, have increased by 48% to 55 million barrels. Oil traders that had contracts expiring on the 22nd were selling at whatever price they could get, as most did not have the ability to take physical delivery of the crude oil. This lead to the price of CLK2020 trading below US$0.
Whilst paying someone to take crude oil initially appears unintuitive, for many traders the cost of taking delivery and storing the crude oil without a confirmed buyer would have been higher than paying another party to take it. Each futures contract represents 1,000 barrels of crude oil, and over 154,000 of these contracts were traded yesterday.
It’s important to note that this crash in price was limited to the May CL contract, which expires on 21/04 at 18:30 (UTC). The June CL contract (CLM2020), which expires on 19/05 at 18:30 (UTC), is still currently trading at around the US$20 per barrel mark. It’s possible that as we near the expiry of the June contract, a similar situation occurs. As Daniel Yergin, vice chairman of IHS Markit, described, “The May crude oil contract is going out not with a whimper, but a primal scream”.
One-minute chart of CLK2020 (white) compared with CLM2020 (red) during the crash
Commodity traders have had a hard time over the past few weeks as banks are becoming increasingly reluctant to extend lines of credit, fearing the risk of catastrophic default.
The situation has not been aided by the loss incurred by fabled Singapore oil trader Hin Leong Trading, as they struggle to repay debts said to amount to at least US$4.3 billion USD. As many as ten different banks are involved in the trading loss saga, with HSBC having the largest exposure at about US$600 million USD.
Access to credit is essential for the high-volume, low-margin business of trading commodities. Lenders in the South East Asian region have reportedly begun asking for more collateral, increased financing costs, and in some cases ceased issuing credit to smaller companies altogether. Following the events of this week in the oil markets, it may not be long before U.S. lenders implement similar policies.
In response to the crude oil crash, President Donald Trump stated that the U.S. is looking to add as many as 75 million barrels of crude to its Strategic Petroleum Reserve. Trump said he was considering the move “based on the record low price of oil”. The President also seemed to speculate at the beginning of the month that bids at US$9 per barrel could get filled.
Crude oil and bitcoin have had multiple instances where price action was correlated. However, as shown in the chart below, the price of bitcoin did not follow that of crude oil during the crash.
Four-hour chart of CLK2020 (white) compared with BTC (red)
Similarly, when comparing crude oil prices to that of the S&P500, there is a noticeable decoupling of trends at the start of April. This continued during the crude oil crash, with little to no reaction from the S&P.
Four-hour chart of CLK2020 (white) compared with S&P500 (red)