How are Brokers Preparing for Potential Negative Oil Prices in May?

In April, history was made when the May futures contract of the West Texas Intermediate (WTI) Crude Oil plunged into negative territory for the first time ever. Although US oil prices have since recovered, the contract expiry for June futures is just around the corner - so what are brokers doing to prepare?

As Finance Magnates reported, May WTI futures contracts went into negative territory as the lockdown measures adopted by the coronavirus pandemic significantly reduced the demand for oil, resulting in much higher supply than demand.

Therefore, as the storage tanks got increasingly full, holders of May contracts preferred to get rid of the contracts as they may have wanted to avoid delivery and the extra storage costs. To put it simply - they were willing to pay other people in order to take the contracts off their hands.

With lockdown measures significantly reducing the demand for oil, it is possible that WTI futures for June could end up the same as the May contracts, as the lockdown measures still remain in place and continue to reduce demand.

Brokers adapt to the new normal

With the expiry of June contracts set for the 19th of May 2020, what are brokers doing to prepare for this? Speaking to Finance Magnates, Jimmy Ye, the Director of ACY Securities, said they are working on a new oil contract.

"ACY Securities has been actively working with several different LPs in developing new Oil contract. The concept is to significantly increase the baseline price of oil, which will enable ACY Securities to offer Positive Pricing while Oil is in negative territory and still have the exact same underlying Oil movement."

Furthermore, the Australian based FX and CFD broker has been increasing the margin requirements for its oil contracts for the last few weeks and alerting its traders to the potential risks, Ye told Finance Magnates.

ACY Securities is not the only broker to try and create an investment product that will provide its users with exposure to oil. eToro recently launched a new long oil portfolio, OilWorldWide, so that retail investors can have access to the oil market.

IS Prime, a Liquidity provider, also created a solution that aims to combat the risks of the spot oil price potentially going negative again by developing two new proprietary products the US Oil Index and the UK Oil Index, which are aimed to combat the inability of brokers' trading systems to accept negative rates.

Brokers caught unprepared

When US oil prices went into negative territory for the first time in April, it caught many brokers by surprise, and the impact this historic movement had on the brokerage industry is still yet to be completely revealed. We do know that Interactive Brokers posted an aggregate provisionary loss of approximately $88 million.

We also know that there is still more losses out there, as the US brokerage firm had around 15 percent of the open interest in the May oil contract, according to its founder, which indicates that other brokers have suffered even more dramatic losses than Interactive Brokers, as the rest of the open interest faces losses.

Nonetheless, it is safe to say that brokers aren't keen to be caught unaware a second time. Although RoboForex doesn't expect oil prices to go negative again this month, the broker is still preparing for the worst.

"As a broker, we are getting prepared, regardless of the fact that it is impossible to trade forward market instruments, and the price of CFDs we trade cannot decline below zero due to technical limitations of trading platforms," Denis Golomedov, Chief Marketing Officer at RoboForex explained to Finance Magnates.

"We have increased the required security for positions in WTI and Brent to 5%. If Volatility increases abruptly, we will discuss switching all trade to "Close only"."

Preparing for negative oil prices

So what are other brokers doing? As Finance Magnates reported, Admiral Markets established an emergency plan in April, with the company outlining to its customers that should any crude oil CFDs fall below $5, then it will enable 'Close Only' mode and stop accepting new orders for the product.

Admiral Markets is not alone in this move. In fact, FXOpen said in an email to its clients that due to the possibility of oil falling to negative prices again, should the price of XTIUSD or XBRUSD fall to $5.50, the market will be suspended and all relevant open positions will be automatically closed at the best possible prices in the market.

Finexo.com and TRADE.com both implemented similar measures, with the former stating that should the price reach $5, all existing Short (SELL) positions shall be closed automatically at market price for Oil (CFD Crude Oil Future) and Crude Oil Cash (CFD Crude Oil Cash).

TRADE.com is only allowing new Long positions (BUY only) for its related oil CFDs, and again, should the price fall to $5, all existing Short (SELL) positions shall be closed automatically at market price.

Will history repeat itself?

Whilst brokers are preparing for further potential negative oil prices, do they currently expect that history will repeat itself again in May?

"Given that we are yet to see signs of significant recovery around the world, we believe the uncertainty will continue for many months to come," Ye of ACY Securities explained. "In the meantime, brokers should keep traders well informed in relation to all upcoming events and help them understand the risks of the volatility we are experiencing. We, for one, are keeping our clients up to date with developments as they happen through our various market analysis products."

Golomedov from RoboForex added: "It is unlikely that the prices for energy carriers will become negative again this month like they were at the end of April. This panic component is already included in the current commodity prices, the market has already experienced such emotions and may never be influenced by them again. At the same time, it should be noted that the oil market situation has not changed much. This means that all risks remain in place and can put pressure on the prices."

In a previous interview with Finance Magnates, Filip Kaczmarzyk, Member of the Management Board, Head of Trading Department at XTB, outlined: "Theoretically I see this happening again, and the main reason for this is, of course, the pandemic lockdown but also the OPEC supply war and storage facilities reaching their capacity limits."

"Unless the pandemic restrictions are lifted, or another agreement between oil drillers is reached, I believe that technically we can experience the same issue at the contract expiration date. However, realistically I do believe one of the above happens, and we don't see a similar situation in the near future."

When will oil demand return?

Whilst brokers are preparing for the worst and hoping for the best, many are wondering when some form of normalcy will return to the oil markets, and demand will return.

Commenting on this, Golomedov continued: "Investors are currently waiting for signals that global oil production has begun to decline due to the actions and agreements of OPEC +. The earliest when we can see signs of a decrease in oil supply over demand is the end of May.

"Then may start counting on some significant fluctuations of oil prices. It seems that the commodities market will remain in unstable for at least six more months. A trend may start unfolding when global economies find a foothold and stop collapsing. As soon as the demand for energy carriers appears, oil quotations will go up. This will happen no earlier than mid-autumn if things go smoothly."