Podcast: should negative oil prices be allowed?

Did negative oil prices signify the market was operating effectively, or that something was wrong?

Oil price drop

The historic plunge of oil prices into negative territory is still a huge talking point in the oil market, even though a return to those levels any time soon looks unlikely. While some people saw the dive through zero on April 20 as a sign that the futures market was functioning as it should, others believe it called into question the reliability of the West Texas Intermediate (WTI) crude oil benchmark.

In this podcast, Henry Lichtenstein and Brett Friedman discuss the issue.

On the one hand, the physical oil market was facing an unprecedented demand shock and the price of some physical crude grades had dropped below zero. On the other, futures prices fell far below the lowest levels seen in the physical market. Lichtenstein and Friedman argue that the plunge of the May WTI futures contract to -$47 a barrel (/bbl) was a distortion, or exaggeration of events in the physical world. As such, the contract was not a useful risk management tool that day, and more should have been done to ensure a less chaotic expiry, they argue.

The fact that the price bounced up the next day to close above $10/bbl shows that the settlement price on April 20  – a price that fed into many averages used to settle hedges – was out of line with fundamentals, they say. They end the podcast by asking whether negative oil futures prices should be allowed, and conclude that this decision should be made by the entire market.   

Lichtenstein (pictured top right, above) is president of Brown Mac Energy, an energy futures trading and compliance consulting firm based in New York, which he founded in 2012. Before that he led an institutional energy sales desk for Newedge and has traded oil futures at various Wall Street firms since 1983.

Friedman runs Winhall Risk Analytics, a risk management advisory firm that specialises in market and credit risk assessment and also trade forensics. He traded oil and power options from the 1980s onwards and was the chief risk officer of hedge fund Ospraie Management.

Index

02:00 Setting the volatility of April 20 in context

05:10 Did market participants realise oil futures could go negative?

05:40 How well did the oil futures markets perform on that day as a vehicle for managing risk?

08:01 Weren’t the futures markets just reflecting the constrained physical market?

09:15 What do you think went wrong on that day and what could have been done differently?

11:01 Were the CME’s advisories communicated widely enough?

15:39 Would things have been different if traders had been aware earlier that prices could go negative?

19:24 Was the assumption that prices couldn’t go negative?

19:40 Should retail investors be allowed in the market at expiry?

20:35 Do mechanisms such as circuit breakers help?

24:50 Was the jittery nature of the market that day exacerbated by the lockdown and the fact that people were working in isolation?

28:00 Should there be a debate on whether oil prices are allowed to go negative?

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