The last couple of days prices action in WTI, a Crude Oil, has raised a lot of interesting questions, especially so about negative Futures and Commodity prices. We will not dig into the reasons for the negative prices, but the current Corona crisis and the storage situation in Cushing,OK certainly played a large part. We view it as unlikely that a lot of the trading was driven by systematic CTAs, ETFs, or retail clients as the trading in the contract was largely dominated by the participant with the capacity to take physical delivery. Most traders had already rolled their exposure.
This post tries to summarize the historical past events that have lead to the perception that negative prices were impossible. And any futures trader knows that certain contract adjustment processes lead to negative prices for certain time series due to the roll adjustments, but that is largely an artifact of math rather than a reality. Typically, commodity markets spike from supply shocks rather than demand shocks.
The May WTI contract dipped to a negative -40.32 on Monday, but the contract expired positive on Tuesday the 22nd, at 9.06. So, anyone holding the contract for physical delivery still had to pay for those barrels. Unfortunately, no free oil to store in the pool.
As many have noted, this is a historical event for WTI. Below we dig through news and books to find out if this happened before and how certain a lot of authors were that it would not happen.
The Team at FT’s Alphaville noted that this has happened for Propane in 2015: https://ftalphaville.ft.com/2015/06/19/2132420/when-commodities-trade-at-negative-prices/ so its certainly not anything new. Alphaville noted that it does not certainly happen every day. But they are one of the few noting that the commodity prices can indeed be negative.
In electricity markets, it happens frequently, as Kyos, a provider of financial technology for energy and commodity markets, noted in a paper: https://www.kyos.com/negative-power-prices/. They note that the storage problem.
However, in the literature, there are a large number of claims that Commodity prices cannot go negative. In “The Trading Game: Playing by the numbers to make millions”, the author Ryan Jones made the statement that cost averaging in commodities was a safe investment the lower the prices were. The book was written in 99.
Another Maestro that had the same opinion was Alan Greenspan that made a similar claim in his biography “The Man Who Knew: The Life & Times of Alan Greenspan”, by Sebastian Mallaby. It also describes the early career of Greenspan as a Fundamental Metals trader.
Speaking to the assumed asymmetric profile of commodities was Paul E Peterson, in 2018, Commodity Derivatives: A Guide for Future Practitioners making a similar statement about non-negative Futures prices and option prices.
The claim was widely and historically held by the “Commodity Futures Law Report (1992)” that a short Futures position was limited to a zero price.
We would like to end this expose of books that need to be updated with Jim Rogers that wrote in his pitch for commodities that the asset class always have a positive value, unlike stocks.
In summary, we were equally surprised to see negative values for WTI as everyone else. It is obviously time to revise a lot of risk and pricing models to incorporate negative prices. And before all of the Trend Followers jump on this and proclaim that their systems would have incorporated this, it is worth noting that the Turtles generally sized shorts smaller, negative N was smaller than the Positive N due to the limited profit potential of shorts.