LONDON (Reuters) – The U.S. Commodity Futures Trading Commission (CFTC) report on volatility in WTI oil futures, published on Monday, has already been criticized for not probing deeply enough into how and why prices plunged into negative territory for one day in April and then rebounded sharply the next day.
For at least one CFTC commissioner, the report does not go far enough. “The report is incomplete and inadequate,” CFTC Commissioner Dan Berkovitz complained in a statement accompanying publication.
“As the regulatory body responsible for ensuring the integrity and fairness of derivatives markets, the CFTC should provide an accurate analysis of the events that caused the sudden and extreme price movement on that one trading day, in a manner consistent with the requirements of the Commodity Exchange Act.
“By leaving out important facts and analysis, the ‘interim, preliminary observations’ in the report do not provide the public with a meaningful understanding of the events of that day and their implications for our markets.”
More penetrating inquiries might reveal uncomfortable information about the trading in the run-up to the expiry of the May 2020 WTI futures contract (CLK0) on April 21.
They might also raise delicate questions about design and supervision of trading in these U.S. crude futures, one of the largest and most important commodity derivatives.
So the CFTC’s report sticks to a safe and uncontentious recitation of the general economic background and some observations about aggregate positions and trading volumes.
Going further might be dangerous until the CFTC has decided whether any traders were at fault or if the contract delivery mechanism and pre-expiry position limits need to be changed.
“This report presents important facts our career market oversight professionals and economists are able to share publicly and includes detailed analysis using non-public information and multiple sources of data,” CFTC Chairman Heath Tarbert said in a statement accompanying publication on Monday.
“While some may have hoped for a more definitive analysis, we simply cannot provide that at this time – just as we cannot confirm or deny media reports of investigations tied to these events.”
The report’s authors are careful to emphasise the limits of the document in a set of lengthy footnotes. In short, the footnotes demonstrate that the report sets out some context but does not attempt to draw any inferences or reconstruct the exact sequence of trading that caused a record fall in prices, followed by a partial but swift recovery.
Though it is described as an interim report, it does not even commit to publishing a final version. “Interim does not suggest that any further reports will or will not be forthcoming,” the footnotes say.
PRICES UNDER PRESSURE
Instead, the report summarises the circumstances leading up to the sharp drop in prices.
The first wave of the coronavirus and accompanying lockdowns destroyed oil consumption but production adjusted more slowly, leading to a rapid accumulation in petroleum inventories.
Crude stocks increased especially rapidly in tank farms around Cushing, Oklahoma, the physical delivery point for WTI, leading to concerns about storage space and questions about the contract’s deliverability.
In the run-up to expiry an unusually large number of futures contracts for delivery in May 2020 were still open at the start of the penultimate day of trading and needed to be closed out urgently.
Prices, which had been under pressure in the preceding days and weeks, tumbled by a record amount over a relatively short period on April 20.
Prices for the May contract disconnected from other WTI contracts, including the next contract for June, as well as other benchmarks, such as Brent.
May futures began trading on April 20 at +$18 a barrel but fell to -$40 at one point before closing at almost -$38. The following day the contract bounced and expired at +$10.
The two-day round trip amounted to swings of almost $98.
The report focuses on the question of negative prices for oil and correctly notes prices below zero have occurred in other commodities, such as gas and electricity. But the real issue is not negative prices but volatility.
Can the unprecedented range of prices on April 20 and 21 be explained sufficiently by fundamental factors (coronavirus, lockdowns, volume war, rising inventories and congestion at Cushing)?
Or did the trading behaviour of one or more market participants contribute to the extraordinary variation and speed of price changes over those two days?
If trading added to volatility, how significant was the contribution? Was the behaviour culpable? If it was not culpable, should it have been? And should either the contract’s design or supervision be changed to prevent a repetition?
These are much more sensitive questions and can only be answered by examining the positions of individual market participants in the days running up to and on April 20.
Tracking and analysing the behaviour and interactions between individual traders, the market microstructure, is necessary to understand how macro fundamentals are translated into observed prices.
Both the CFTC, as regulator, and the Chicago Mercantile Exchange (CME), as contract operator, have access to all positions down to the level of individual traders.
In the past, investigations have examined individual bids, offers, transactions and open positions in an attempt to reconstruct their impact on market prices.
Both the CFTC and the CME may be performing such reconstructions at the moment; but if so, they chose not to make the results known in this report.
Positions and trades are ordinarily confidential. So unless the CFTC or the CME choose to bring an enforcement action, or otherwise share the results of their investigations, we will never know.
As outsiders, we are left with an observed set of fundamentals and an observed set of price movements, but no way of linking the two.
We can construct a narrative that emphasizes fundamental oversupply and soaring stockpiles. Or we can create a story that centres on manipulation, liquidity holes and contract failure.
Unless we have more information about the market microstructure, we have no basis on which to prefer one narrative or the other, or a blend of both.
(John Kemp is a Reuters market analyst. The views expressed are his own)