When Crude Oil Price Went Below Zero at Mcx Ltd.: Black Swan Event

Multi Commodity Exchange (MCX) Ltd. of India offers derivative contracts across precious metals, base metals, energy products and select agricultural commodities. Since its inception in 2003, MCX Ltd. has introduced futures contracts on a wide range of commodities, including bullion (gold and silver), energy products (crude oil and natural gas), and base metals (copper, zinc, aluminium and lead). Commodity exchanges are significantly different from regular stock exchanges. Stock exchanges normally offer listing and trading in financial products such as equity shares, bonds, mutual funds, debentures, and futures, options on these financial products. In India, the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) focused predominantly on financial products, while the two commodity exchanges, MCX and NCDEX (National Commodity & Derivatives Exchange), focused on commodity derivatives products. MCX maintains a dominant position in precious metals and energy, commanding over 99% of the market share, whereas NCDEX specializes exclusively in agricultural commodities.

During the COVID-19 pandemic, global travel restrictions and lockdowns led to a sharp decline in global crude oil demand, which, in turn, created a severe shortage of available storage capacity worldwide. As storage space disappeared, traders holding long futures positions, who were obligated to take physical delivery as part of NYMEX crude oil futures contracts, faced extreme logistical constraints. Consequently, they began liquidating their positions at any price, leading to the unprecedented episode of negative prices in NYMEX crude oil futures contracts. Eventually, on April 20, 2020, New York Mercantile Exchange (NYMEX) crude oil futures prices traded at the Chicago Mercantile Exchange (CME) entered negative territory. It is worthwhile to note that although NYMEX crude oil futures contracts have been trading since 1983, this marked the first instance of prices turning negative, representing a classic black swan event. Since the settlement price of MCX crude oil futures contracts maturing on April 20, 2020 was benchmarked to the NYMEX crude oil futures price, MCX initially announced an interim settlement price of INR 1 per barrel on April 20, 2020. This was later revised to a negative settlement price of INR 2,884 per barrel, corresponding to the NYMEX price of negative USD 36.37 per barrel. The negative settlement price resulted in losses of approximately INR 500 crore for Indian traders who were holding long futures positions after contract expiry.

Although loss of this magnitude is not uncommon in derivative markets, negative futures price is an extremely rare and unprecedented phenomenon, making this episode a significant event in the history of commodity derivatives markets. A group of brokerage firms in India had jointly filed a petition in the Bombay High Court against MCX Ltd., challenging the settlement of crude oil futures contracts at a negative price of INR 2,884 per barrel. The petitioners argued that since the MCX crude oil futures contract was financially settled rather than physically deliverable, it should not have been settled at a negative price. They further contended that assigning a negative settlement value was arbitrary and lacked economic rationale. They asserted that Indian commodity exchanges do not have the power to assign negative value to commodity futures contracts.

The case tracks major events surrounding the COVID-19 period lockdown until April 20, 2020, which is also the expiry date of the MCX crude oil futures contract, and delves into the wide range of concepts related to commodity derivatives, including future pricing, margin, open interest calculations, the role of the clearing house, storage capacity and mechanics of physical settlement and more importantly, how MCX addressed this rare event.

Learning Objectives

• To grasp the mechanics of futures contracts, specifically the importance of futures contract specifications
• To understand various concepts such as cost of carry model of futures pricing, open interest, difference between financial settlement and physical settlement of commodity futures contract, etc.
• To appreciate difference among hedgers, speculators and arbitrageurs in the context of derivatives markets
• To appreciate why futures price of crude oil contracts went into negative territory even though Covid-19 pandemic affected all forms of business as well as all types of commodities
• To explore the role of commodity market regulator to address such unique events

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