A negative spin to crude’s mysterious slide | FT Alphaville

A negative spin to crude’s mysterious slide

People are still scratching their heads over what possibly sparked crude oil’s sell-off in the middle the US trading day on Monday.

Explanations in contention include: fat fingers, SPR talk and general illiquidity due to the Jewish New Year.

Yet one of FT Alphaville’s own beady-eyed commenters immediately noticed that the slump coincided almost exactly with the following report from Reuters:

(Reuters) – The ECB could cut its main interest rate, put its deposit rate into negative territory and offer banks a new round of ultra-cheap funding, policymaker Luc Coene said on Monday, adding Spain’s borrowing costs would soar again without a support programme.

ECB Governing Council member Coene said it was “very unlikely” that the ECB would ever engage in outright quantitative easing but that the central bank had a number of other options to ease monetary policy.

“You could further lower interest rates, you can also try to extend the LTROS to some extent, you can also do some LTRO with private credit claims as collateral,” he said during a seminar organised by the European Economics and Financial Centre.

Timing-wise it works. The slump in crude commenced at 13:45 New York time, while the Coene flashes came out at almost exactly the same moment (the below is UK-time):

There’s also the fact that Brent seemingly led the slide, which might account for the European angle.

As Olivier Jakob at Petromatrix noted on Tuesday:

We will note that volume started to increase on the break of 115.00 $/bbl Brent, that the sell-off took place three minutes after Brent broke the support of 115.00 $/bbl and that the sell-off was concentrated in less than one minute. Brent lost -2.60 $/bbl in less than one minute, and WTI -3.02 $/bbl and this with a surge of volume. All of this without any visible headline. On the other hand, with some market participants on holiday for Rosh Hashanah we can speculate that there were probably some resting stop orders below 115.00 $/bbl which could have helped trigger the move which then accelerated. The less than one minute selling however was bought back on the break of the Brent 200 day moving average at 111.84 $/bbl, and it is therefore difficult not to view this sell-off as technical trading/high frequency trading on dope.

So why would the prospect of negative rates spook the crude so much more than any other market?

Well, here’s an interesting point from Emad Mostaque at Religare Capital:

We believe this drop was the start of a return to fundamentals as Brent in particular moved to a level of backwardation not justified by any supply disruption with the back end of the curve over $20 below the front end compared, for example, to the Libyan disruption last year, when the whole curve moved up. A move of this magnitude on no particular catalyst is no longer rare and we saw this last April, August, September and this April too. It is simply indicative of an overbought condition brought about by a dysfunctional market structure.

As we’ve explained before, ‘unjustifed’ backwardation could and would be one logical side-effect of negative rates, since the ‘time-value of money’ component in the cost of crude storage equation would have to be taken away rather than added to.

The idea being that in a negative rate world, financing conditions continue to reward the physical market for stockpiling even when the market is backwardated. The backwardation thus has to get much steeper to incentivise destocking and/or equilibrium, as we have previously illustrated with these graphs:

Naturally, if that was the real explanation for the slide, it would imply that somebody somewhere was fully up to speed on how negative rates would and could influence the market. More so, that that somebody was large enough to influence the market, albeit on a low liquidity day.

For now we agree that sounds like a long shot, but it’s worth putting the idea out anyway…

And now, we’re also hearing now that it could have been an options expiry issue. Additional theories and rebuttals welcome in the space below.

Related links:
The negative carry universe – FT Alphaville
Pariah profits in an age of ‘negative carry’ – FT Alphaville
Outing the aluminium squeeze, Deripaska style – FT Alphaville
The oil-bound – FT Alphaville