Negative crude oil price: Lessons for SEBI, bourses, investors, broking houses

As crude price futures slipped below zero last week, there was a hue and cry from the investors fraternity, broking houses and even the exchanges. The Multi Commodity Exchange (MCX) was forced to settle the April crude oil contract price at minus ₹2,884. The settlement price at expiry was derived from the nearest expiry contract at Nymex, the US exchange, where the crude price closed at an unimaginable negative value of $37. This resulted in a hole in brokers’ and investors’ wealth with a loss of about ₹400 crore.

Miffed with the MCX’s decision to settle its April crude futures contract with negative pricing for the first time in the history of commodities trading, broking firms including Motilal Oswal Financial Services and Religare Securities filed writ petitions in high courts against the exchange and against market regulator SEBI.

MCX, which initially announced a provisional settlement price of ₹1 for the crude oil futures contract that expired on April 20, later calculated a price of (-)₹2,884 per barrel, leading to investors losing about ₹435 crore.

A number of investors who are facing losses to the tune of about ₹50 lakh are protesting through various channels including Twitter sending SOS to SEBI, Finance Minister and PMO to protect them from this calamity.

This incident is turning out to be a harsh lesson for everyone.

Not only zero, but below too

The most important lesson is for retail investors in derivatives, who may have so far thought that the price cannot go below zero in futures trading. You may be trading in any asset class, be it gold, interest rate futures, currency or equity and other commodity futures. But, beware that your investment cannot only go to zero but possibly below it too, wiping out your wealth too in a jiffy. So, one should not trade in any asset class where he or she cannot fully understand the risk or fundamentals associated with it. Futures trading is mostly speculation where one needs to be multi-dimensionally talented and have lateral thinking to understand fast moving events.

For brokerages, investors’ financial safety should be the primary objective rather than business revenues. Allowing a lot of investors who do not understand risks will not only damage that individual but also the broking house’s prospects. Crude oil is not the first incident. In fact, a few years ago a number of traders burnt their fingers on guar gum futures, though the intensity was less at that time. When investors speculate aggressively and take positions beyond their means, brokers should dissuade them from doing so.

This is the right time for SEBI to allow retail investors only in index-based commodity futures where at least 10 assets are part of the index with equal weightage. Though index-based trading may not be risk-free, at least this would ensure manageable risk at both brokerages and individual levels.

At crisis times like this, SEBI should hold routine press briefings to highlight the enormity of the problem and give clear instructions to investors/ brokerages and even to the exchanges on dos and don’ts. SEBI may be engaging with exchanges and custodians, but it must address retail investors too.