'Thin' CFTC report on negative WTI crude oil prices comes under severe attack

By Brad Rosen, J.D.

Just prior to the Thanksgiving holiday, the CFTC’s Division of Market Oversight (DMO) and Office of the Chief Economist (OCE) held a press briefing and issued its controversial report regarding the events surrounding trading in, and the expiration of, the NYMEX WTI May contract on April 20, 2020. While the report provided background, context, and observations in connection with the WTI’s precipitous decline on that day from $17.73 per barrel to a settlement price of -$37.63 per barrel, critics were quick to point out that the report was incomplete and inadequate.

Commissioners clash. In a CFTC press release, CFTC Chairman Heath Tarbert noted that the report included detailed analysis using non-public information and multiple sources of data. The chairman stated, "While some may have hoped for a more definitive analysis, we simply cannot provide that at this time—just as we cannot confirm or deny media reports of investigations tied to these events." He added that "we believe it is in the public interest to be transparent with the substantial information we do have and can share at this point in time." For his part, Commissioner Dan Berkovitiz responded, "The Report fails to determine the cause of the unprecedented plunge in the price of the WTI futures contract and divergence from physical markets on April 20, the penultimate day of trading in the May contract." Berkovitz added, "Rather, it provides a general recitation of economic conditions in the weeks and days leading up to April 20, and offers only aggregated statistics regarding trading on that day."

A review of fundamental factors. During the press briefing, DMO Director Dorothy DeWitt underscored a number of fundamental factors discussed in the interim report that led to the unprecedented market action in the WTI crude May contract. These included:

• an already oversupplied global crude oil market at the beginning of 2020;
• an unprecedented reduction in demand caused by COVID-19; and
• concerns about the availability of global crude oil storage in Cushing, Oklahoma.

DeWitt was careful to point out that the staff analysis did not address whether any trading on April 20 was deemed to be abusive, disruptive, manipulative or unlawful, noting that such determinations were beyond the scope of the report. She also said that while the publication is styled as an "interim report, that does not infer whether or not there will be a subsequent staff report on this subject in the future."

Technical factors come into play. At the briefing, Scott Mixon, the Office of the Chief Economist’s acting director, highlighted a number of technical factors related to market structure that came into play during the April 20 trading session. These included:

• Open interest (OI) in the May Contract was much higher than usual in the weeks prior to the expiration of the May Contract, and specifically at the start of the April 20 trading session.
• The majority of traders holding positions in the May Contract had traded out of their positions prior to April 20.
• OI was high entering the April 20 trading session, but the number of reportable traders holding positions at expiry on April 21 was consistent with prior contract months.
• Limit order book activity related to multiple products showed a decrease in liquidity in the May Contract, with the decrease starting well before April 20.
• The speed and magnitude of the price moves observed on April 20 in the May Contract, particularly between 1:00 p.m. and the end-of-day settlement at 2:30 p.m. Eastern Time, were exceptional despite the triggering of exchange-based control mechanisms designed to impose pauses in the event of rapid or large price moves.

Position limit rule disregarded. Commissioner Rostin Behnam expressed irritation that the events of April 20 were not adequately considered in evaluating the CFTC’s recently enacted final position limit rule. In a separate statement, the commissioner pointed out that during the recent public comment period for the position limits rule proposal, which remained open through May 15, the CFTC received at least eight comments that addressed the events of April 20. He further noted that rather than appropriately addressing these comments and the issues raised, the Commission instead compartmentalized the significance of the underlying factors at issue with regard to the findings and directives relevant to the position limit regime, and pushed ahead with enacting the final position limit rule. Behnam also noted that the interim report may also have implications for the CFTC’s proposal regarding Electronic Trading Risk Principles, which Chairman Tarbert has indicated will be considered by the Commission in December of this year.

What’s next? As noted, Director DeWitt was uncertain whether the interim report will be the final word on the events of April 20 concerning the WTI May crude oil futures contract. If Commissioner Dan Berkovitz has anything to say about it, this matter will remain open. In his view, "It is crucial for the Commission to fully understand the collapse in WTI crude oil futures on April 20, 2020, and to share that understanding with the public as soon as possible." He also asserted, "[T]he issuance of an incomplete preliminary Report is a disservice to the public, market participants, and small and large businesses that depend on a reliable crude oil futures benchmark for contract pricing, risk mitigation, and price discovery." He concluded, "The Commission should continue to analyze the events of April 20 and provide a complete and accurate report to the public as soon as possible."

Joseph R. Cisewski, Senior Derivatives Consultant and Special Counsel for Better Markets, a market watchdog group, echoed the commissioner’s sentiments, noting: "The report doesn’t identify a root cause for negative pricing and doesn’t state much with confidence. Instead, it claims to be an interim report, with preliminary views, which presumably means those views may change in the coming months." Whether the CFTC will further examine these events with the arrival of the Biden Administration in 2021, time will tell.