Financial markets in the last few years have been anything but usual. GameStop’s share price was $400 (pre-split). Nikola Motors briefly had a value greater than Ford. NFTs were valued at millions.
The most crazy market moment of the pandemic period wasn’t a cryptocurrency, meme stock or SPAC. Sweet, sweet crude was the market’s most insane moment.
The oil market was shocked by the unexpected: Before GameStop, DogeCoin barked and Trump tried making SPACs great, DogeCoin barked.
Oil will hit a -$40 barrel on April 20th 2020.
Oil costs around $90 per barrel today. You could have received $40 for taking delivery of the same asset two years ago.
It is unlikely that oil will ever turn negative again. This is a truly “once in a lifetime” event. These rare events also present once-in a lifetime opportunities.
The story of the fortunes made and lost on the day that the oil market collapsed.
The bottom of the article contains links to additional sources. All data points are linked.
Paul “Cuddles Commins” prepared to face another day of trading on April 20th 2020 in Essex, England.
Cuddles, a commodities trader with a wealth of experience and a nickname he earned in the pits at London’s International Petroleum Exchange. In the 1980s and 1990s, IPE’s trading pit was like a Wild, Wild West, where The The Wolf of Wall Street met Peaky blinders
Cuddles, along with eight other traders, started Vega Capital in Essex as algorithmic and high frequency trading became mainstream.
Some of the nine members of Vega Capital were sons or friends of Commins, and they operated legally as independent traders. However, they worked together a lot. They could often be seen drinking beer and watching West Ham United while they were not at work.
The lads of Essex were preparing for a busy day on April 20th. The last trading day of the May WTI Crude oil futures was approaching. The CME warned that the price could drop to zero or even go negative as the contracts for May approached their expiration date.
How did we arrive here?
Back up two months.
In February 2020, students were planning their spring breaks, millions were commuting five days a week to and from work, March Madness would soon be here, and the Chiefs just won the Super Bowl.
In two months, a lot of things can change.
In March, the air travel industry came to a screeching halt. Students were sent back from their colleges, and employees in white collar jobs around the globe ditched their offices for their homes. There were no sports, concerts or live events. Cities resembled ghost towns in I Am Legend.
Oil prices have not been this low since 1998 as air travel and commuters are no longer allowed. OPEC talks collapsed on 6th March, after Saudi Arabia stunned the world with increased production and slashed prices despite lowest oil demand for decades.
Oil investors stored cheap oil temporarily with the intent of selling it once prices recovered.
The oil market imploded due to a combination of factors: a collapsed demand, an increasing supply and a lack of storage. To understand the reasons for this, one must travel to Cushing, Oklahoma, in the heartland.
Futures markets are used to trade commodities such as oil. Oil futures contracts are available (each contract represents 1,000 barrels), but the most popular derivative is West Texas Intermediate Crude (WTI).
Brent Crude oil, which is based in the North Sea of Europe, can be settled with cash at expiration. This means that no oil has to be exchanged. Contract buyers and sellers can exchange the cash value of the asset for its closing price.
WTI oil contracts do not allow cash settlement. Anyone holding an expired WTI contract is required to take delivery of 1,000 barrels. You can’t just fill your swimming pool with black metal, you must take delivery at Cushing, Oklahoma. Cushing, a landlocked oil hub in the middle of the US, is filled with storage tanks and pipelines.
Due to the forced delivery of contracts held until expiration, most traders simply closed their WTI positions prior to the contract expiration. Only energy companies and other operators were interested in taking delivery.
When the oil markets are functioning well, buyers can simply receive their fuel via pipelines, storage tanks, and fuel trucks.
This oil market was not functioning correctly.
Due to the price collapse, it became more profitable to store oil than sell it immediately. Cushing is landlocked and because investors are renting out all the storage space available, it will be hard for buyers to get their hands on the oil.
With just one day left until the expiration of May WTI futures on April 20, Cushing’s storage capacity was near zero.
Our British traders.
The May WTI futures contracts began trading at $17.63 the night before when the markets reopened. The price fell over the course the day, and by the end of the session it was at $10 a share.
Cuddles’ team and Cuddles, believing that market weakness would persist, decided to short expiring contracts. They used a TAS (Trading at Settlement) contract to avoid any delivery risks.
TAS contracts are a great way to trade futures contracts at a price within 5 ticks of that day’s contract settlement.
An example:
If WTI is $20, and you believe it will fall over the next day, then you “sell” WTI futures at $20 per barrel. You would also buy the same number TAS contracts. If WTI drops to $10, then you will lock in a profit of $10 (or $10,000 because each contract represents 1,000 bbls), per contract. You sold your contract at $20 and you profited by the $10 drop because you bought back your contract at $10.
You are not required to deliver oil if you buy and sell the same number contracts. Contracts cancel each other out and your profit or loss is based on price movements. You can also do the opposite: buy WTI and sell TAS to bet on a positive price movement.
You’re clear enough? Cool.
They were willing to take a risk on this day because they thought oil prices would continue to fall. They shorted WTI futures for around $10 per contract and planned to cover the shorts with TAS contracts at the end.
The Brits bought TAS contracts to offset the WTI contracts they sold. Prices remained static for the next few hours. They were nervous because they knew that the market would be more volatile near 2:30 PM, when trading ends and settlement price calculations are made.
Their short bets may quickly lose value, costing millions, if a surge of buy orders occurs in the afternoon.
Then, it happened.
It wasn’t the buy orders that caused an activity spike. The traders began to liquidate everything.
Why?
The contracts were not sold because there was no storage at Cushing. The oil could not be delivered, so WTI contracts were a hot potato game where no one wanted the bag at the end of the clock.
As sellers panicked, prices plummeted. Nobody wanted to be tied down by expiring contracts. WTI fell from $5 to $0. The unthinkable occurred with 20 minutes left of trading.
Oil has turned negative for first time in history.
What about Cuddles’ team? They smelt blood and went to the killing.
The Guardian reports that text messages show they tripled their bets when the price went negative.
Please read the following texts with a British accent.
One message read: ” For years we have pushed eachother so hard to get this moment… and we f*cking blitzed, boys,.” Keep selling it every five points, said another. ” you’ve got to just keep selling,” another said. ” Everybody is going to have ammo,” said another. “F*cking mental. “I want to see negative WTI price,” said another.
They won big on their bet. What is the settlement price?
-$37.63.
How much did they earn? Let’s do some math. You “buy back” your contracts when you buy TAS and short WTI contracts.
If you sell for $10 and then buy back the barrels at -$37.63 you will make $47.63 per 1,000 barrels or $47,630 profit.
The lads in Essex also sold many contracts.
What is their final one-day gain?
About $
$73M, plus or minus a few millions.
What do you do when you earn $100M in one day? You can do whatever you like.
Harry Lunn is a trader who founded an international team of polo players that competes in Argentina. Elliott Pickering created his own racing firm, and now drives Ferraris. Aristos demetriou bought a $200,000 mansion, and several $200,000 vehicles.
Every trade has an opposite party. What about a trade which nets $660M per day? Someone had to lose. In this instance, it was several people.
The volatile oil market enticed many traders to also try their hands in commodities. Commodities are a risky game for novice traders because of the leverage involved. One bad bet can leave you with far more than you invested.
The CME warned on April 15th, that the May WTI price could be negative at expiration. However, retail-friendly brokers such as Interactive Brokers failed to prepare.
Syed Shah was one of many traders who thought the bottom had been reached when oil prices dropped below $0.0. Shah, 30, who had $77,000 on his account at the start of the day, was shocked when he received a notice saying he owed $9 millions.
Interactive Brokers saved these traders with a write-off of $104M for the brokerage.
It wasn’t only retail traders that made bad bets. The Bank of China lost the most money in the oil crash.
The Bank of China has launched a new investment product, “Crude Oil Treasure”, (COT), to offer individual customers trading services related to oil futures.
BOC knew exactly who they were aiming for, as early ads asked, “Is it possible to find a product that is profitable and interesting for new investors without financial knowledge?” Absolutely! “That is a treasure trove of crude oil!”
The companies conveniently ignored any disclosures of risk, reassuring investors ” That regardless of whether crude oil prices rise or fall, they can always make money“.
There are no guarantees in finance. The COT was designed so that investors could not lose more than the initial investment , as long as prices were above zero.
Bank of China traders, believing that negative prices posed zero risk, took the opposite side of Paul Commins’s trade on April 20th. They bought WTI futures and sold TAS contracts. Bank of China traders, assuming that negative oil prices were a zero-risk trade, took the opposite position on April 20th. They bought WTI futures while selling TAS contracts.
What is the $660M profit of Cuddles and Company? The $1.4B Bank of China loss is nothing compared to that. The retail investors were responsible for the losses, not the bank.
Many investors, who thought their money was safe, found themselves owing twice as much to the bank as they invested.
The Bank of China agreed to compensate investors for losses due to negative oil prices a month later. However, they only offered to reimburse up to 20% of the original investment.
I am shocked and I really mean it that a product advertised as “ An interesting but profitable product for new investors without financial knowledge ” has imploded.
What is the final figure, assuming that all investors have been paid by Bank of China? $1.84B.
It’s bad.
