Markets Set the Price...
Image from CME Website
Not sure how we frame the moves that the oil futures contract market had today but not only did the May contract quote the lowest price for Oil ever recorded, but it actually went negative! That implies that the Oil for delivery in May is not only worthless but actually costs money. This makes sense somewhat as we have heard the issues with storing oil and the potential costs it may have if lucky to find somewhere to store it. In addition, there are stories that oil producers rather lose on every barrel than shut the oil wells which could destroy their ability to produce in the future.
While investors seek the rationality of these prices, many consequences are still yet to be seen. When price changes occur this way, many holders are exposed on the wrong side of the trades as these markets of options and futures (derivatives) are a zero sum game. Someone is being left with this not only worthless asset but the costs to deliver (nor not). This must have led to some margin calls which just impact liquidity concerns even more. Most investors would normally think that their assets are only exposed to being reduced to zero but to go negative is unprecedented. This contract was down 300% today which could make many holders insolvent almost immediately on paper if the risk was not mitigated.
This also brings the concern of counterparty risks all over again. Like the days of the financial crisis, many derivatives were at risk of not being settled as the counterparty or the person on the other side of the trade did not have the financial capacity to do so. This is what brought giants down to their knees and in immediate need of bailouts in the financial crisis. While I think that the government has already showed their hands of not allowing this to happen; can you imagine the outrage at another bailout in the commodity trading side? Many are already under fire because of hedge funds and private equity receiving government funds to remain solvent.
Time will tell and with another day of trading left before the May contract expires, I am sure we will soon hear the unforeseen consequences of these market moves. However, markets remain irrational as not only this price demonstrates but also the fact that equity prices did not collapse relative to the changes in oil prices. While many have shifted to look at the next month's contract, there continues to be millions of dollar worth of oil exposure in this contract. Watch for more bailouts to continue...
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