The WTI crude May (front month) contract in NYMEX crashed into the negative territory last Monday. This followed a historic jump in US crude oil inventories in Cushing, Oklahoma, the delivery point for NYMEX crude futures, due to a drastic fall in demand.

On April 20, the day before the expiry of the NYMEX WTI crude contract of May, buyers with open long positions refused to take delivery due to storage constraints in the Cushing hub, but were ready to pay the sellers. This saw the price of WTI crude May contract plummeting. Here, we answer key questions on how the unprecedented developments in WTI crude trade on NYMEX impacted traders on MCX.

Why did an event in the US impact oil traders on MCX?

The MCX crude oil contract is settled based on the prices of WTI crude futures, front month contract, traded on NYMEX (CME Group), a commodity exchange in the US.

 

In view of the countrywide lockdown to fight Covid-19, commodity exchanges in India, in consultation with SEBI and market participants, had announced closure of trading in all commodities by 5 pm everyday during the lockdown period. Futures trading in crude oil, precious metals and industrial metals, and other contracts, which were earlier open for trading till 11.30pm, is closed by 5 pm from March 30. On April 20, the NYMEX WTI crude oil contract for May slipped into the negative terrain. Given that it was the day of expiry for the contract at MCX, ie its April contract, the settlement price at NYMEX had to be relied upon.

The prices at NYMEX, meanwhile, were reflecting the underlying storage constraints at the Cushing hub, which effectively saw the buyers in futures holding open positions not wanting to take delivery.

Traders in the domestic market MCX crude contract could only watch the WTI prices plunge as they could not exit their positions because the had trading ended at 5 pm.

In the intervening night between April 20 and April 21, the MCX Clearing Corporation released a circular indicating the Due Date Rate (DDR), the price at which a contract is settled at expiry.

The circular said: “Due to unprecedented level of volatility in crude oil price in international markets, the DDR for MCX crude oil contract that expired on April 20 is yet to be finalised, and in the interim, the provisional settlement price is considered as ₹1 per barrel for computation of obligations of members.”

Why did the settlement price turn negative for MCX traders?

Clearing and settlement operations for trades on MCX are taken care of by MCX Clearing Corporation Ltd (MCXCCL), a wholly owned subsidiary of the former. MCXCCL’s midnight circular  shocked traders with open (long) positions in crude futures at MCX as trading in the contract was closed on MCX at ₹965 per barrel on April 20.

The next afternoon, on April 21, the Clearing Corporation came up with its next circular.

It announced that the DDR of crude oil futures that expired on April 20 would be minus ₹2,884 per barrel. This was calculated based on the settlement price for the May contract of WTI crude oil futures in NYMEX, which was minus $37.63/barrel (converted into rupees at the reference rate of 76.6335).

How can negative price work in a market that is cash settled?

Unlike the NYMEX WTI crude contract that is settled by physical delivery, on MCX, the crude oil futures is cash-settled.

So, brokers and traders who lost money and were upset with the exchange, said that in a market that is cash-settled, the settlement price can’t be negative.

But as per the contract specification for MCX crude oil futures, approved by SEBI, the settlement on the expiry day has to be based on the NYMEX WTI crude oil front month contract’s settlement price. This is what has been done. Brokers have moved the Bombay High Court against the MCX Clearing Corporation settling the contract at negative price.

How much money traders lost?

As per MCX open interest (OI) on the expiry day, there were around 11,500 lots that were open at end of session on April 20. The loss for a trader with long position thus would have been over ₹ 2.8 lakh per lot.

This is because the settlement price as announced by MCXCCL was minus ₹2,884 per barrel.

Given that one lot is 100 barrels, the loss comes to ₹2,88,400. As the trader would have purchased his lot at a price that could be ₹965 (closing price of April 20) or above, his loss would be over ₹2.8 lakh.

Say, a buyer ‘X’ had an open position at ₹ 1,000 per barrel in MCX crude oil contract of April 20 expiry. With the close price of ₹965 per barrel on April 20, he was expecting the DDR to be somewhere close to that price.

His position would then be settled by the Clearing Corporation at a loss of about ₹35 per barrel, which is ₹3,500 per lot.

But when DDR was announced on April 21, it was minus ₹2,884 per barrel, which means, at his buy price of ₹1,000 per barrel, his loss now comes to ₹3,884 per barrel, that is ₹3,88,400 per lot.

At 11,500 open positions, the total loss for all those who had open position comes to ₹400-430 crore. The calculation here is 11,500 contracts x 100 (no of barrels per contract) x 37.63 (DDR) x 76.63 (exchange rate conversion of dollar vis-à-vis rupee) plus the actual cost of the buyer. If taken at ₹965 per barrel, the cost for the buyer will be = 11500 x100 x 965.

Could all these have been averted if the exchange had not curtailed trade timing?

It is true that had the trade timing not been curtailed by SEBI at the request of the exchanges and participants, the losses would not have been as high for those with open positions at close

As crude prices crashed that night, they would have closed their open positions. But it is also true that this situation should have been anticipated by traders as also brokers.

On April 8, the CME (Chicago Mercantile Exchange) issued an advisory notice to its clearing members that there is a potential of a negative underlying in certain energy option contracts, and followed this up with another advisory on April 15.

This should have sent alarm bells ringing for the exchange and the brokers in India who trade on crude oil futures.

The spectre of negative prices should have made the brokers caution their clients, and exchages should also have been prepared for the same.

Could this situation have been handled better?

MCX, MCXCCL and SEBI, along with market participants, failed to anticipate the risk of closing trading early in the globally referenceable commodities traded on MCX. Given that NYMEX trades round the clock, with only one hour of break in a day, and the expiry of the April contract was due at MCX, the participants and exchange could have prepared for extending the trade timing on the expiry day, at least, says a market expert.

Also, it is not known whether it would have been feasible and whether the exchange and participants had approached SEBI seeking any modification to the existing contract specifications with regard to the settlement price on expiry, considering that the exchange was closing at 5pm, while the NYMEX settlement price would have been available only at 14.30 Eastern Time, ie, 12:00 midnight in India.

Note that usually on an MCX crude futures contract expiry day, MCX takes the NYMEX settlement price arrived at from the volume weighted average price (VWAP) of trades between 14.28 ET and 14.30 ET (11.58 pm - 12.00 am IST).

How prepared are MCX and SEBI to handle the  repetition of negative price quotes in crude oil?

The exchange has not yet announced any details or a policy about how it would handle a zero or negative price quote during trading hours if international prices move to negative, again. It needs to be noted that MCX’s trading platform presently does not have a facility to have a price quote in the negative, other than in case of certain spread instruments.

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