Crude Oil is traded in India on the commodity exchange (MCX). This is the exchange where all other types of commodities like Gold, Copper, Cotton, Natural Gas, etc. are traded in India. MCX is to commodities like NSE is to stocks.
How Crude Oil is traded?
Just like all other commodities, the trades are taken as futures contracts and are settled in cash. This means there is no physical settlement of the actual commodities involved. One can simply buy and sell crude oil just like any other stock without having to worry about taking the physical delivery of the same.
What are Crude Oil futures contracts?
In the commodity markets, the unit of trading is different for each commodity. For eg. for gold the unit is “grams”, for copper it is “tonnes”, for cotton it’s “bales”, etc. For crude oil, the unit is barrel (BBL). This is the standard unit of oil trade in the international markets.
- 1 barrel = 160 litres.
- Minimum lot size for trading crude oil contracts is 100 barrels.
Normally, MCX markets are open in India from 9:00 AM to 11:30 PM. Due to the COVID-19 pandemic, nationwide lockdown was imposed on 25th March 2020. Stock markets were not closed and were meant to operate as usual. This gave rise to a lot of debate among experts and media houses as to why the stock markets are still kept open while the entire nation is in a lockdown. There was a lot of pressure to “close the markets”. Closing the markets is never the solution as doing so entirely disrupts the demand and supply dynamics which is core of an open market. Nevertheless, that is a topic for another article.
Finally on 30th March 2020, MCX decided that instead of closing the markets entirely, they would revise the market timings. The revised timings were 9:00 AM to 5:00 PM.
The cost of trading Crude Oil
On 20th April, Indian commodities markets closed at 5:00 PM as per the revised timings. At the time of closing the crude oil contracts were trading at ~₹1500 per barrel. This means the cost to buy 1 contract (100 barrels) of crude oil would be ₹1,50,000.
Now most brokers provide their clients with “leverage” trading facility. What this means is you don’t need to have the full amount required to buy these contracts. You just need to deposit a certain portion of the total amount with the broker to buy the contract. This portion is known as the “margin” money. For crude oil contracts this was around 40% for most brokers. Which means you need to deposit only ₹60,000 (40% of ₹1,50,000) to buy 1 lot of crude oil futures.
The D-Day: Oil Market Crash
The US markets opened (around 9 PM in India) on 20th April. Immediately after opening, crude oil prices started falling down rapidly. The crash was severe and within a few hours, the prices had already crashed from $20 to $1 which is almost a fall of 95%. Since it was the last day of the monthly contract expiry, everyone just sold out in panic to avoid carrying the position into next month.
Normally, Indian commodity markets are open till 11:30 PM. So Indian traders get 2-3 hours of buffer time after the US markets open. Looking at the US markets they can decide on whether to keep their positions open or close them. But on this fateful day, the traders were helpless as markets were closed at 5:00 PM as per the revised MCX timings. They just saw the prices crash and could do nothing about it.
The Negative Prices
Finally, when the US markets closed, the oil contracts settled at -$37. Yes you read it right, it’s “minus” 37. This was the first time something like this had happened ever since the oil contracts started trading on US markets in 1983. This was clearly a black swan event as no one anticipated that prices would fall into negative values. As the prices were falling, a lot of traders in the US exited their positions in losses and even a lot more traders who did not act quickly went on to lose heavily as the prices crashed into negative territory.
The Impact on Indian markets
The next day i.e. on 21st April 2020, the MCX released a circular about this event. As per the circular the settlement for the crude oil contract was -₹2884! Read that again and let it sink in. It’s “minus” 2284 per barrel! This was calculated at an USDINR rate of 76.63. Below is a screenshot of the MCX circular.
Now let’s calculate the cost of the impact. Imagine that at the time of market closing on 20th April, you were holding 1 contract (100 barrels) of crude oil. For this you were using the leverage trading facility provided by your broker. This means you had deposited just the required margin money which was ₹60,000 (as per above calculation).
After the crash, the cost was:
- Per Barrel: -₹2884
- Per Contract (100 barrels): -₹2,88,400
So the contract that you were holding till yesterday and which was valued at ₹1,50,000 at the time of holding suddenly dropped in value and is now worth a “minus” -₹2,88,400!
You have not only lost the margin money of ₹60,000 that you had deposited with the broker but now you also have to pay an additional sum of ₹2,28,400 to the broker to settle your contract.
This is calculated simply as the difference between the two prices: -2,88,400+60,000 = -2,28,400.
In India, SEBI mandates that all the brokers who provide leverage trading facilities to their clients should take the responsibility of market settlement in such an event. The brokers can then settle the accounts with their clients separately on a later date.
How much is the total loss?
At MCX market closing on 20th April, there were around 11,500 crude oil contracts outstanding in Indian markets. This means the total impact is around ₹350 crores for Indian markets. Brokers who do not have this much cash available at hand will go bankrupt as they will not be able to settle the outstanding contracts. Other brokers who can absorb this impact will have a huge impact on their balance sheets.
India’s top broker, Zerodha has suffered a loss of around ₹10 crore due to this event. The net worth of their commodity broking business is ₹100 crore. That means, this event has eroded 10% of their net worth. Many other small brokers who will not be able to sustain such an impact will go bust and close shop. The true impact will be seen in the days to come.
As for the traders, they will have to deal with their brokers and finalize on their settlements. To give a real world analogy of this event, let’s take an example of your home. Assume that your home is worth ₹1 crore today. Something happens in the night and when you wake up tomorrow morning you are not only forced to sell your home for free but additionally you’re forced to pay ₹25 lakhs extra to the buyer of your home. How would you feel about it? That’s the exact feeling oil traders across the globe are going through.
Only one word can describe this event – Disaster!
I hope I was able to explain the details of this event in a simple way. If you still have any queries or feedback, write to me at firstname.lastname@example.org
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