The plunge in U.S. crude futures prices for May delivery the day before the contract’s expiry this week will revive questions about the contract’s design and whether it can continue to serve as a useful benchmark.
FILE PHOTO: Crude oil storage tanks seen from above at the Cushing oil hub in Cushing, Oklahoma, March 24, 2016. REUTERS/Nick Oxford
Previous dislocations in 2009 and between 2011 and 2013 prompted calls for a review of the contract but without forcing much change. Cushing was chosen as the delivery location when light sweet crude futures were launched in the early 1980s because it was already an active trading hub for physical crude.
That represented about 44% of all working storage capacity in the Midwest, but only 12% across the whole country .Futures prices for light sweet crude delivered to tank farms and pipelines at Cushing normally maintain a reasonably stable relationship with the price of other crudes at other locations across the United States and around the world.
Most U.S. crude contracts are offset financially before expiry. Less than 1% of contracts are taken to physical settlement in normal circumstances. But users have the option of physical settlement, at least in theory. So the sharp drop in prices was concentrated in only one futures contract on the last trading day before expiry.
Daily turnover in the May contract was less than 250 million barrels on Monday, compared with 775 million barrels for the same contract a week earlier and almost 1.1 billion barrels at the start of the month. But Cushing has been filling steadily for weeks, while the price plunge occurred in the space of a few hours. That looks like a flash crash triggered by the imminent contract expiry, exacerbated by very limited liquidity and concern over physical delivery.The situation at Cushing’s tank farms is not fully representative of the United States as a whole.
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