Inside the Biggest Oil Meltdown in History
Leah McGrath Goodman
Institutional Investor
May 06, 2020
What took place instead was 20 minutes of unalloyed chaos, followed by another 24 hours of teeth gnashing, confusion, and bewilderment as the market collapsed in the face of the global Covid-19 pandemic and arguably the swiftest economic downturn the world has ever seen.
While much remains in question, one fact cannot be contested: In all of market history, this had never happened in a standardized, exchange-traded contract, let alone the most heavily traded benchmark crude oil contract in the world, representing the lifeblood of the world’s industrialized nations.
In the minute between 2:08 p.m. and 2:09 p.m., 83 futures contracts for West Texas Intermediate light, sweet crude oil, scheduled for May delivery to the oil hub of Cushing, Oklahoma, rapidly exchanged hands at $0 a barrel. With each contract consisting of 1,000 barrels, this meant that, at least on paper, 83,000 barrels — or 3.5 million gallons of oil — effectively went off the market for free. That same minute, oil prices, encountering little resistance, jackknifed lower to trade at minus 1 cent a barrel, touching off an unprecedented freefall into negative territory.
“We’d been hearing about the possibility of negative oil prices for weeks,” says Bob Iaccino, chief market strategist for Path Trading Partners, a trading analytics firm in Chicago. “Everyone was like, is it really going to happen? There were a lot of ‘holy shits’ as the bottom fell out, a lot of people not fully understanding the concept of what was going on.” Even now, more than two weeks later, traders still seem to have widely varying recollections of what transpired, with one saying prices unraveled “very quickly, even from a futures market perspective,” and another calling it a “slow-motion train wreck.”
A closer inspection of the events reveals that, in many ways, both are true. “Of course, the first time this would ever happen it would be in crude oil,” says John Kilduff, founding partner of Again Capital, a New York–based hedge fund specializing in commodities investments. “I feel like, somehow, crude oil is always part of the problem. Just look at what happened in 2008, when we had our last major economic crisis — it went to nearly $150 a barrel, then crashed the same year. It has a rich history.”
In March — nearly a month to the day before oil’s collapse on April 20 — Citigroup global head of commodity research Edward Morse projected that oil prices might turn negative. On April 8, CME Group — which hosts the West Texas Intermediate crude oil futures contract — sent out a notice stating it had “a tested plan to support the possibility” of negative prices in its major energy contracts. Still, it wasn’t until the wee hours of the morning on April 20 that the canary in the coal mine appeared: The premier of Alberta, Canada, Jason Kenney, tweeted the warning, “Western Canadian Select oil is now trading at negative prices.” (The oil, which derives from Canada’s tar sands, usually trades at a discount to West Texas Intermediate crude oil futures, which were tanking.)
Traders were hurrying to extract themselves from positions in the May crude oil futures contract because it was expiring the next day, Tuesday, April 21, after which it would begin its delivery phase in Cushing. Already eviscerating oil prices was the global pandemic, a crippling supply glut, and a concomitant slump in energy demand. Cushing’s unique logistics and geography complicated matters further: The tiny, landlocked town, nestled in the flatlands of the Great Plains and possessing some of the greatest onshore oil storage facilities in the world, was nearly full, making physical oil deliveries increasingly difficult. Even if market participants wanted to accept oil barrels for delivery — and many of them didn’t — they likely would have nowhere to put them. In short, many were forced to hastily offload their oil futures contracts over the next 24 hours, at whatever price they could get.
“I’ve traded futures and I’ve seen a lot of short squeezes that sent oil prices exploding higher in both the physical and futures markets,” says Tom Kloza, global head of energy analysis at oil price service OPIS. “But I have never seen a long squeeze like this. Before the week of April 20, I don’t think most people thought prices could even go negative. But once that happens, it means you can lose more than 100 percent of your investment. You’re talking about infinity.”
At 2:29 p.m. on April 20, one minute before settlement that Monday, a single May crude futures contract traded at the jaw-dropping price of negative $40.32 a barrel, marking the lowest handle ever witnessed in the most liquid crude oil contract in the world — a previously unimaginable nadir. “Between 2:25 p.m. and 2:30 p.m. it was like watching a Fellini movie,” says Kloza. “You’re able to appreciate it, but no one really knows what’s going on. The screen was just going nuts.”
Andy Hall, the legendary oil trader who retired in 2017 from Astenbeck Capital Management, his multibillion-dollar hedge fund, was looking over prices that day, as is his wont.
“I do still watch it every day,” he says. “I suppose old habits die hard. What I saw was very chaotic. I saw a lot of buying and selling toward the end. I am sure a lot of people thought, ‘If I buy at zero, what can I lose from that?’ Well, it turns out you can lose over $40 a barrel.”
By 2:30 p.m., crude oil futures settled on the New York Mercantile Exchange at negative $37.63 a barrel, shedding 306 percent of their value on the day and far surpassing the record low, set during the oil price crash of 1986, of $10.42 a barrel. Notably, May oil futures never even traded at the settlement price of minus $37.63. It was just a “volume-weighted average price from the settlement window,” according to CME Group, the parent company of Nymex.
One could almost hear every energy trader’s mobile phone across the Western hemisphere blow up. “I actually got a call from the White House,” says Again Capital’s Kilduff. “They wanted to know what was going on — and what to tell the president.”
In all, 14,913 crude oil contracts exchanged hands at negative prices on April 20, according to CME data. In other words, on average, sellers were paying buyers to take oil off their hands at a rate of more than 31 million gallons a minute. In a surreal turn of events on what was already a superlatively surreal day, President Trump announced during a White House press briefing that he would be happy to accept any free barrels of oil for the nation’s Strategic Petroleum Reserve (SPR). At negative prices, he reasoned, he wouldn’t need any funding approvals from Congress. “If we could buy it for nothing, we’re going to take everything we can get,” he told reporters. “The only thing I like better than that is where they pay you to take the oil.”
Of course, Trump was conflating his markets. The negative prices primarily stalked the May crude oil futures contract, not the markets for physical barrels. If the president was waiting for people to line up to help him fill the SPR with millions of barrels of free oil, says one trader who oversees physical oil trades in both the U.S. and Canadian markets, he’d still be waiting. “We saw a few negative trades, but nothing like what was happening in the oil futures market that day,” he says. “I think the consensus among physical traders when we see crude futures get that chaotic and wonky is not to trade them. Sometimes it’s just better to sit things out.”
Traders who were holding out for May oil prices to turn positive again ahead of expiration were rewarded. On the evening of April 20, one lone crude futures contract ventured back into positive territory, trading at 5 cents a barrel, just before slipping below zero again in the early hours of Tuesday, April 21. While May oil futures struggled to recover, the rest of the Nymex crude oil complex, as well as prices for Brent crude oil, stayed positive. On the day of expiration, May crude oil futures finally managed to build some small, halting gains, expiring at $10.01. Since then, crude oil futures prices have not turned negative again. And they won’t, Kloza says. “I believe — and I think this is the consensus view — that there will be many more protections put in place going forward to make sure negative prices don’t recur.”
Michel Marks, the father of the Nymex crude oil futures contract, which launched on March 30, 1983, says anticipating trading cataclysms and global calamities — like the Covid-19 pandemic — is all part of the job. But that doesn’t necessarily make it easy.
“Black swans are hard to anticipate,” he says. “The bottom line is to maintain a fair and orderly market.”
While the breakdown in crude oil futures happened swiftly, the windup to subzero oil had been percolating for weeks, if not months, with both oil supply and demand under increasing strain as the global pandemic spread from Asia late last year to the U.S. by January. With cities around the world on lockdown, flights grounded, and people sheltering in place across continents, oil demand had dropped precipitously in recent months — even as supplies surged to record levels.
Against this backdrop, the dumping of cheap oil on the market by the Organization of the Petroleum Exporting Countries (OPEC) amid a price war between Saudi Arabia and Russia further weighed down energy prices. While a deal reached in April among OPEC, Russia, and other allied producers to trim oil supply by 9.7 million barrels a day may ease the pressure on energy futures, it likely won’t take effect for weeks and may still not be enough to boost prices.
In the end, the total amount won — and lost — by oil traders active in the negative price range on April 20 came to well over half a billion dollars, based on May crude oil’s volume-weighted average settlement price. Among the market participants caught in the crossfire were clients of Interactive Brokers, the online brokerage firm based in Greenwich, Connecticut, which said it was forced to tap into $88 million of its own reserves to cover several customers’ trading losses. The company’s chairman, Thomas Peterffy, said in a recent conference call that the brokerage was still trying to sort through the mess. “We were up most of the night trying to figure out what was going on, and we still do not have all of our facts completely in order,” he said in late April. In an interview with CNBC, Peterffy noted bloodletting across the industry. “There is about another half a billion dollars of losses that somebody is sitting on . . . and I do not know who those folks are,” he said.
Some of those losses may very well be tied to the Bank of China’s “crude oil treasure” investment product, which reportedly sold May oil futures contracts near the all-time lows, leaving Chinese retail investors exposed. Estimates for the potential loss to investors amid the market melee have come in as high as $1 billion, but the numbers are still preliminary. One fund coming under pressure has been the United States Oil Fund, the largest exchange-traded fund tracking near-term oil prices, which lost a large chunk of its value the week May crude oil futures took a bath.
Many of the market participants caught in the crossfire were not sophisticated investors, but simply members of the retail public who did not understand how oil futures contracts work — and that they can expire or trade negative. When pressed about these investors’ portfolio losses, CME chairman Terrence Duffy, who appeared on CNBC in the aftermath of negative oil prices, did not mince words. “Futures contracts have been around for hundreds of years and I will tell you, since Day 1, everybody knows that it’s unlimited losses in futures,” he said. “So nobody should be under the perception that it can’t go below zero.”
One trader who benefited from the market carnage was Pierre Andurand, one of the world’s top hedge fund managers and the head of London-based Andurand Capital Management. He began betting against crude oil futures earlier this year, believing that until an effective vaccine for Covid-19 is found, the global economy will remain in its doldrums. He traded against crude futures on April 20, but said he exited the market, taking profits, before prices turned negative.
Still, a number of economists, executives, and former exchange officials found negative oil prices very concerning, noting that if physical traders were shying away from the market, it could mean there was a problem with price discovery — a key function of the exchange-traded markets.
“Why did the U.S. benchmark crude oil futures contract settle at negative $37 a barrel while everyone else in the world had a real price?” one former exchange official asks. “The futures market demonstrated no convergence with the physical market that day. It demonstrated no convergence with reality.”
Veteran oil economist Philip Verleger expressed similar misgivings, calling for immediate reforms by the U.S. Securities and Exchange Commission, as well as the Commodity Futures Trading Commission, to ensure negative oil futures prices would never happen again. In a recent market note, he wrote that the negative price swings “represented a failure of the market that, if allowed to repeat, will threaten the global energy industry’s entire financial foundation.” He added, “The Chicago Mercantile Exchange allowed individual traders or producers to put their precarious financial circumstances ahead of the interests of the industry or consumers.”
Commodity Futures Trading Commission chairman Heath Tarbert called the oil price collapse a “temporary dip,” adding, “The CFTC is obviously watching these markets closely and in real time and our main job as a regulator is to make sure whatever’s going on in the market is actually reflective of real supply and demand and not anything else.”
With U.S. gross domestic product expected to contract by 25 percent or more in the second quarter, and traders roundly expecting Cushing oil supplies to top out in May, the benchmark crude oil futures contract will be lucky to have only temporary dips — and not another dalliance with the downside.
But have some perspective, notes Marks of Nymex fame.
“There are more important things in life,” he says, “than the price of oil in Cushing.”