All stakeholders must share blame for MCX crude futures crisis

The crisis in the settlement of April contracts of MCX crude oil futures is a result of oversight on the part of all stakeholders — the regulator, intermediaries, exchanges and traders — and should serve as a warning about the kind of unforeseen risks that can spring up due to the Covid-19 pandemic. However, traders who were long in the contracts had to pay a heavy price, losing over ₹400 crore, and many brokers are now suspending trading in these contracts in an effort to avert further losses. The genesis of the problem was in the sharp drop in demand for crude due to the ongoing pandemic, that caused a historic jump in US crude oil inventory in Cushing, Oklahama — the sole delivery point for WTI crude futures. With storage full, buyers with open positions refused to take delivery and were willing to pay the sellers for the commodity. This resulted in WTI crude prices plunging deep into negative terrain on April 20, the settlement day of MCX crude futures, that are referenced to WTI crude futures traded on the NYMEX.

The decline in WTI crude contracts on the NYMEX resulted in the settlement price of MCX April crude contracts being pegged at negative ₹2,884 per barrel, resulting in losses to those who had ‘buy’ positions. Intermediaries of MCX have many reasons to feel disgruntled. One, their clients were unable to act quickly to square their loss-making position on April 20 because SEBI had revised the closing time for commodity futures trading to 5 pm from the earlier 11.30 pm, due to the Covid-19 pandemic. Two, negative prices are unprecedented in Indian commodity derivative markets and the exchange software did not have any provision for the same. Three, brokers are uncertain about the ability to collect margins from clients if contract value goes negative, since the margin value would be over 100 per cent of contract value. MCX, however, stuck to the rule book in arriving at the settlement price.

That said, the exchange has been negligent in not taking note of the advisory issued by the CME in mid-April, wherein it had warned that crude oil contracts could move to zero or negative values due to lack of storage space. MCX should have warned its members and asked them to close their positions. The exchange also needs to issue a circular about how it plans to deal with negative pricing in crude contracts in future and modify its trading platform to accept negative valued bids. The brokers and traders who actively transact in these contracts should also have kept abreast of the developments overseas, which were critical to the pricing of the Indian contract; particularly around the settlement day. This should also serve as a reminder to SEBI that the numerous relaxations given to handle the Covid-19 crisis are likely to lead to new complications.

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