The global oil market descended into a new low in April after oil prices crashed into negative prices for the first time ever.
On April 20, May West Texas Intermediate (WTI) futures contract sunk by an unprecedented 310% to minus $38.45/barrel, marking the first time that a futures contract for U.S. crude prices went negative and wiped out thousands of investors.
Negative oil price is a bizarre situation that essentially means that oil producers have to pay traders to take the worthless oil off their hands.
Whereas U.S. investors have been forced to take the loss to their chins, their brethren to the east can at least take some comfort in the fact that some brokers are being made to pay for drawing in unsuspecting customers.
Bank of China Ltd, one of the biggest providers of the ill-fated oil futures, has been fined a grand total of $50.5 million yuan, or about $7.7 million after investigations found it culpable.
Unfortunately, as happens so frequently, that fine is hardly fair comeuppance for the thousands of disgruntled Chinese investors.
Horrendous losses
According to the South China Morning Post, Bank of China clients suffered massive losses exceeding 7 billion yuan (~$1 billion), after oil prices crashed into negative territory in April for the first time ever. The bank had initially estimated losses at ~600 million yuan ($85.7 million) as the debacle unfolded but was hit with harsh reality after gathering more information from more than 10,000 banking outlets.
Those levels of losses would be easy to comprehend in the western world, but not in an economy that’s still regarded as being far from open.
For many decades, the Chinese financial markets remained a tightly controlled affair that largely locked out foreign and exotic investments. But that started to change during the last decade with the country’s capital markets slowly but surely moving into the global investment mainstream. Two years ago, the world’s largest oil importer achieved another milestone after it launched crude oil futures trading that allowed its citizens to participate in the giant market.
While the futures market largely flourished during its first two years of existence, it did not take long for the proverbial ‘Yang’ to arrive: Chinese investors are now much more exposed to the wild swings of foreign markets.
WTI Collapse
The massive losses by Chinese investors stemmed from the oil price crash on April 21 that sent WTI prices deep into negative territory. The ill-fated May contracts underpinned Bank of China “Crude Oil Treasure” that it launched in May 2018, leaving thousands of customers counting their losses and demanding that the bank should shoulder some of the pain.
Source: BloombergQuint
As many as 60,000 customers had invested in the product as per a report by Chinese publication Caixin though the Bank of China does not disclose those figures.
The bank’s crude futures appear to have rapidly gained in popularity, challenging well-established crude futures markets just a few months after their launch.
In January 2019, investment firm Jordan Knauff and Co(JKC) reported that daily trading volumes for front-month crude futures at the Shanghai International Energy Exchange clocked in at nearly 250 million barrels, ~20% of global trading in similar contracts and pretty close to Brent front-month futures trading volumes. Mind you, that was less than a year since their launch.
Source: JKC
The losses could have been a lot worse, though.
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The Bank of China doesn’t allow any leverage, which is a good thing because applying leverage would have made those losses much bigger. The bank revealed that ~46% of the investors liquidated their positions a day before the contracts were due for settlement, while the rest either chose to settle at expiry or rollover their positions.
The result: Investors lost 4.2 billion yuan of their margin and another 5.8 billion yuan owed to the bank.
However, just like its U.S. peer, the USO ETF, which quickly moved its money from near-term to longer-term contacts in a bid to minimize risk, Bank of China went a notch higher after suspending trading in the product, with China’s other big banks following suit.
Unfortunately, China and other global investors that lost billions in that crash can only revel in some schadenfreude but remain as susceptible as ever.
The United States Oil Fund, LP (USO) has lost 69% in the year-to-date, more than 2x the 31% YTD loss by the Energy Select Sector SPDR Fund (XLE).
By Alex Kimani for Oilprice.com
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