Future(s) Games

On April 20, that fateful day in crude oil markets when the CME May contract for WTI at Cushing collapsed to negative $37.63/bbl, the number of contracts involved in the chaos was relatively small. So you might think that most producers sat on the sidelines, watching Wall Street paper traders writhe in stunning financial pain. But not so. Almost all producers saw their crude prices that day crashing in exactly the same magnitude. That’s because the daily price of the CME WTI contract is part of the formula pricing used in a very large portion of crude oil contracts in U.S. markets, both directly and indirectly. There are two formula mechanisms that are commonly used in crude oil sale/purchase contracts that are responsible for that linkage: the CMA and WTI P-Plus. These arcane pricing mechanisms are complicated, but in order to understand U.S. crude markets, it is critically important to appreciate how they work. Today, we continue our deep dive into crude oil contract pricing mechanisms.

On Monday, front-month WTI at Cushing cratered to a negative $37.63/bbl. On Tuesday, the same futures price rose by nearly $48 to close at about $10/bbl — a positive $10, that is. As for WTI to be delivered in June, it lost well over a third of its value on Tuesday, ending up at less than $12/bbl, but over the past two days it has roared back to over $16/bbl. No doubt the WTI futures market will see more wild times in the days and weeks ahead as traders look to avoid the traps that ensnared the market as the May contract approached expiry. If there’s a lesson to be learned from the past week, it’s that it really helps to understand the ins and outs of the futures market — especially when it is so volatile. Perhaps the most important thing to wrap your head around is that while the futures market mostly involves financial players who will never take physical delivery of oil, the two markets — financial and physical — are fundamentally linked. Prompt-month futures converge on spot prices over time, while physical contracts are settled in part based on NYMEX futures, so producers will feel the sting of Monday’s negative prices when physical April deliveries are invoiced. Today, we begin a two-part blog series examining U.S. spot crude pricing mechanisms.