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Unfathomable drop in Nymex crude oil prices suggests futures market is broken

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(Kitco News) - There are many commodity market watchers who have never trusted the futures markets, which they call “paper” markets. Today’s unprecedented price action in Nymex crude oil futures that saw prices settle at minus $37.63 a barrel, has even the most veteran energy market watchers picking themselves up off the floor, while the futures markets naysayers are saying, “I told ya so.”

The severe glut of spot crude oil on the U.S. market—due to the Covid-19-induced major demand shock--finds no place for the physical oil that is presently being produced to go, as storage capacity in the U.S. is virtually none.

Crude oil futures traders stood shell-shocked Monday when Nymex prices overnight traded down to $13 a barrel, and in morning New York trading dropped below $10, then traded at 1 cent in early afternoon, before settling over $37 in minus territory. That’s a closing price of down $55.90 from Friday’s close of $18.27 a barrel in May Nymex crude oil futures.

The May Nymex crude oil futures contract expires Tuesday, so there is one more day of potentially wild trading. The June Nymex futures contract today settled down $4.00 at $21.03, suggesting that in the coming few weeks, oil prices will rebound—or will they? At least a few oil analysts expect the same situation as today to occur when the June futures contract nears expiration in late May.

How can crude oil futures trade below zero? That’s a valid question being asked by those who are not familiar with the intricacies of the futures markets. Here’s what happened in crude oil futures today. The speculators who had been long the futures market were looking down the barrel of taking delivery of physical crude oil that they were going to own when the May futures contract expires Tuesday, and they had no place to put it. Speculators trade commodity futures markets with no intention of ever taking delivery of the physical commodity. However, it’s that physical delivery potential that is supposed to keep the futures market in sync with the cash, or spot market. Thus, the speculators were willing to pay to get out of that potentially disastrous situation of having to accept delivery of physical crude oil. On this day, a trader could literally not give crude oil away.

It’s likely some big hedge funds were caught on the wrong side of the crude oil futures market (long), and very badly. Last week, when oil futures were trading around $20 a barrel, the seemingly smart money was reckoning a quick U.S. economic recovery would push Nymex futures back above $25, or higher, in short order—just like the stock market had rebounded recently. Seemed like a no-brainer, right? Many of those “smart” traders on Monday were mortally wounded and a few will be forced out of the industry for good. There are a couple of old futures market-trading adages: “Markets will do anything and everything to frustrate the largest number of traders.” And: “Any time a trade seems like a no-brainer, you will likely lose your assets.” Both fit the crude oil futures market action seen today.

Is the crude oil futures market, which is one of the most liquid and highest-volume traded futures in the world, broken? Look at the monthly continuation chart for nearby Nymex crude oil futures—dating back to its inception in 1983 (37 years). Today’s trading range had a high of $121.21 and a low of minus $40.32. That’s a daily trading range of $161.53 a barrel! Tell someone who was already wary of futures markets that the crude oil futures market is not broken—at least temporarily—and you will likely be laughed at.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.