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Oil in the Tank

oil glut extreme delivery conditions economic disruption

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#1 flyers&divers

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Posted 21 April 2020 - 06:51 AM

At yesterdays closing in West Texas Intermediate grade Crude Oil futures trading  the expiring contract  price went off the board at a negative value of -$37.60/ barrel. 

So oil was tendered for less then it is changing hands in normal commerce.

It was due to a special aspect of current delivery specifications (which will be fixed in time) but it is also symptomatic of the effect of

overproduction against a dramatic temporary drop in demand.

 

The crude oil futures contract specifies that actual physical crude has to be tendered by the seller at an Exchange Clearing House Certified storage facility.

For the West Texas Intermediate grade Crude oil contract in question there is only one such facility, it  is the intersection of pipelines in the middle of the crude oil tank farms in Cushing, Oklahoma. 

Basically at that spot exchange officials meter the quantity and spot check the quality of oil as it is piped into whichever tank is chosen.

 

Certified delivery requirements evolved over time in this market and others because there was frequently fraud or attempted fraud involving the quantities and

quality of delivered commodities and sudden changes in delivery mechanisms that favored one party over others.

 

The New York Mercantile Exchange who originated Oil futures trading in the late 1970's (they were later bought out by CME) was even banned from trading certain commodities for a decade by the Feds

because there were frequent scandals involving Salad Oil, Potato and Onion trading.  When I was a trader in sugar in the late 70's early 80's other floor  traders jokingly told tales of potatoes going to zero and people would take delivery just to have the sacks.

 

The purpose of the First Notice Day (FND) is to alert traders that at the end of trading the delivery mechanism has to take place flawlessly and traders of the physical commodity 

should make arrangements so that they can perform and buyer to be ready likewise. Small traders at that point lieve the scene because the clearing house raises margin many fold to non hedgers.

 

 << While the holder of a futures contract is obligated to fulfill the terms of the contract, most futures contracts are closed out well before delivery may occur. To avoid delivery and the costs of retendering, futures traders need to fully understand First Notice Day (FND) and Last Trading Day (LTD).

First Notice Day (FND): The first day the exchange can assign delivery to accounts that are long futures contracts.For physically settled contracts, the exchange may assign delivery starting on first notice day and every day thereafter to Last Trading Day. The trader or hedger who is short the futures contracts may request delivery starting on First Notice Day. For every short who initiates the delivery process, the exchange will assign delivery to the long contract. The exchange assigns deliveries to the futures contracts that have been open the longest.To avoid deliveries, traders and hedgers who are long futures must be out by the close of the day before FND. If you are not flat heading into the close of the day before FND, you will be long the futures on the statement heading into FND, and they\ exchange can assign delivery. 

Best practices for all traders is to be out two trading days before FND. This way if there are any out trades or errors, you still have a full trading day to get any issues fixed before FND. Traders who still want to be long can always roll into the next month.

Last Trading Day (LTD): The last trading day a futures contract may trade or be closed before delivery.

For physically settled contracts, any trader holding a long or short contract into the close will be part of the delivery process. >> that's a quote from Collins Commodities.

 

Suppose a buyer purchased the contract at Friday's close at $18.27/barrel for $18.270 they would then watch it dropping $55.900 to - $37.630at Monday's closing. If they waited for the end of trading and become a seller they would have to transfer  the physical oil and pay an additional $43.763 to the buyer.

Some oil transportation company or hedge fund may have capacity secured  at Cushing and had a nice payday. On the other side heads will roll.

 

A trader could also have purchased that contract at the time of closing of trading for -$37.63 a barrel basically paying MINUS $37.630 USD to the buyer

for the oil, meaning they would get paid for taking the oil instead of paying for the oil. If they had client lined op or existing contract to fulfill they would make the difference of the -$37.630 and whatever they sold it for, appr 55K. 

How dramatic this is, in most years the ENTIRE TRADING RANGE for crude one crude contract was less then that !

 

Most contracts are closed out before FND and If between two parties some oil is agreed to be delivered not to Cushing but to an other location or seaport instead they take care of it with discounts and premiums to the Cushing benchmark which involve transportation, finance, and insurance etc. charges.

That makes commodity trading very interesting because each of those layers are also opportunities to make or lose money.

While a speculator is going without a safety net a hedger with a properly structured transaction has some cushion built in. For them it is not a two dimensional but a three dimensional game.

 

One has to stop for a moment and think. How does this affect the economies tied to the price of oil and the overall economy? Which are bullish and which are bearish, how to play the relationships?

Could the delivery system in other futures contracts fail, even if temporarily?

 

Regards,

F&D


"Successful trading is more about Sun Tzu then Elliott." F&D

#2 gismeu

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Posted 21 April 2020 - 07:04 AM

Thanks heaps for the explanation!

gis
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#3 gismeu

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Posted 21 April 2020 - 07:21 AM

.

Edited by gismeu, 21 April 2020 - 07:22 AM.

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