The US-Iran war has made things very complicated for the oil market, not least needing to balance out supply and demand dynamics. But from a financial perspective, it is also getting a bit dicey in trying to price out the difference between paper oil and physical oil. I talked a bit about the massive $30 to $50 gap in oil prices last week here and how that might impact trading conditions in the coming week.
While the market mood remains calmer on renewed hopes of a US-Iran deal, there’s still much to be careful as we slowly approach the cutoff date for WTI crude May contracts next week. When expiry day comes, think of it as anyone who is still caught in a short position and not having the oil for physical delivery will have no choice but to scramble to buy back their contract at any price to exit.
And considering the price gap, it could be a case where whoever does have their pants down are going to be in for a liquidation event for the ages. Rightfully, the only people left holding these contracts nearing the cutoff date will be those who actually want or have the oil to deliver on them. Think refiners and producers here in this instance.
So, how will we know if there is going to be a liquidation event where many traders get caught on the wrong side of the trade?
We can’t know for sure but there are certain tell signs we can look at.
The first is to look and CME volumes and open interest on the May and follow up June contracts. In the case of WTI crude, we can see that:
The volume are still high for the May contracts are still high, suggesting that traders are still trading the headlines with regards to the US-Iran conflict. However, open interest at the close continues to fall significantly while that of the June contracts continue to push up.
The latter is a clear enough suggestion that “smart money” has already moved on from the May contracts to June/July contracts to avoid the chaos in the coming week. In essence, one can argue that June is arguably the proper front-month contract for WTI crude at this point.
As for Brent crude, the cutoff date is at the end of the month and so the open interest still very much favours the June contract for now:
The issue with open interest continuing to decline further is that it is also a signal that the market is getting thinner i.e. lower liquidity. And that means price action will be more susceptible to volatility spikes, that especially if the price gap to the physical market is still present and there are traders wanting out before the cutoff.
The open interest shift is a good suggestion that “smart money” or big financial players are already trying to skip the drama and focus on betting on prices. It leaves the May contract left for actual physical players as noted above.
So come next week, there could be a jarring moment on the screens where we could see oil prices spike up to around the $110 to $130 range right before the May contract expires and then come back down to the $90+ range once we get into the June contract.
It’s not so much of a case that the price “crashed” after a massive spike but rather the futures/paper market resetting upon the rollover.
