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Oil Futures Long traders in crude oil on the MCX must learn to take the losses

Posted on 24-Apr-2020 Comments  0

Oil Futures 

Long traders in crude oil on the MCX must learn to take the losses

On the evening of 20th April, the WTI oil futures contract dipped to a low of $-37.66/bbl due to a sharp demand drop. The shortage of storage in the US also took the US crude into negative. In the process, it created a unique problem  for oil traders on the MCX.

How MCX got hit by crude oil?

Crude oil futures on the MCX are one of the most actively traded commodities and the price of crude is benchmarked to the NYMEX crude (WTI). Now this WTI is distinct from Brent Crude and is largely used in North America. The MCX preferred the WTI futures because it was futures for delivery whereas the Brent Crude was futures for cash settlement. Hence, WTI was aligned to spot prices more closely. Of course, the crude contracts in the MCX were meant for cash delivery only. When trading closed at 5.30 pm on 20th April at MCX, the MCX Clearing Corporation set the settlement price at Rs.1 which would have resulted in a net loss of Rs.110 crore on the 11,600 contracts of open interest outstanding. However, by the end of US trading, crude had closed at $37.66 and MCX had to eventually modify the settlement price at Rs.(-2884) per barrel. This resulted in a total loss of Rs.442 crore; an additional loss of Rs.332 crore over the original figure. This loss would have to be paid by the long traders in oil to the short sellers, who would have gained from this trade. That became the bone of contention.

What long traders say?

Long traders on crude are upset about a number of factors. Firstly, the MCX system has no facility to factor in negative settlement price. Of course, this is more of a technical issue. The second objection is more pointed. MCX had changed the trade closure time from 11.30 pm to 5.30 pm due to COVID-19. As a result, long traders in India did not get an opportunity to square off their long trades, which they should have been able to do had the normal timings continued. Thirdly, some top brokers have taken MCX to court to stop the payout. However, the MCX has already completed the payout for that particular settlement leaving the issue open to a long and protracted legal battle. What happens from here on?

Welcome to “Caveat Emptor”

The Latin phrase “Caveat Emptor” translates as “Let the buyer beware”. That means any person entering into a contract must be fully conscious of the fine print of any contract. That applies to crude oil futures contracts too. Buyers are obviously fully conversant with the risks and they cannot take umbrage from convenient interpretation of words. If crude is benchmarked to the US WTI, then it has to accept the settlement price, whatever it is. Any other price would be unfair to the traders who where short on crude. After all, trades have to work both ways!

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