Oil prices slid 10% from July’s peak as OPEC+ raised oil supply. Where is it headed and what should investors do next?
Oil prices came off their peak in July, after OPEC+ announced that it would be gradually increasing supply to reverse its previous 5.8 million bbl/day production cuts by September 2022. West Texas Intermediate (WTI) crude oil prices fell 10% from its 52-week high of US$75.25 to about US$67.50 in mid-August. This latest development could not have come at a worse time for the crude oil market, as the increased supply is expected to dampen prices.
Crude oil markets had been in the midst of a dramatic recovery from the record lows of 2020 – when the Covid-19 pandemic caused domestic and international travel to grind to a halt – and returned to pre-pandemic levels as recently as early July. The recovery was driven by the reopening of major economies like China, the UK and the US which had made vaccines widely available. Growing economic activity and higher consumption patterns drive demand for electricity, transportation of goods, and in turn drives up demand for oil.
On the other hand, pandemic-related concerns continue to weigh on the global economic recovery and its corresponding demand for oil. The now-dominant Delta variant continues to cause breakthrough infections among vaccinated individuals, creating new waves of infections in countries that previously had the virus under control and renewing fears of fresh lockdowns.
With the uncertainty and volatility remaining on the near-term horizon, some investors have turned to crude oil futures, including the newly launched Micro WTI Crude Oil futures, to manage their crude oil price exposure.
Here’s what you need to know about crude oil market, and how futures contracts could be applied in your portfolio.
Trading crude oil
Crude oil is a fossil fuel that is extracted from the earth and turned into energy products and plastic. The most desirable form of crude oil is light sweet crude oil. It has a low sulphur content, and is most easily processed into gasoline and diesel.
Light sweet crude oil can be bought and sold globally through spot contracts. However, investors prefer to trade the commodity through futures contracts. A crude oil futures contract is an agreement between two parties to sell and purchase a number of barrels of crude oil at a pre-fixed price on a pre-determined date.
Crude oil is the world’s most actively traded commodity at present, with two main benchmarks for oil futures. West Texas Intermediate (WTI) light sweet crude is the main benchmark for oil produced in North America, and trades on the New York Mercantile Exchange (NYMEX). Brent blend light sweet crude oil originates from the oil fields in the North Sea and is traded on the Intercontinental Exchange (ICE).
Between the two benchmarks, The NYMEX traded benchmark WTI crude oil futures contracts offer greater liquidity, which allows investors to enter and exit the market more quickly.
What is the Micro WTI Crude Oil futures contract?
The newly launched Micro WTI Crude Oil futures contracts are the bite sized version of the benchmark WTI Crude Oil futures. At just a tenth of the standard contract, the Micro contract allows investors to manage their crude oil price exposure more precisely. It is cash settled and does not involve physical delivery of crude oil.
With many existing contracts already on the WTI, why would this new contract matter to investors? Here’s how it differs from its larger counterparts.
|Micro WTI Crude Oil Futures||E-mini WTI Crude Oil Futures||WTI Crude Oil Futures|
|Contract size||100 bbl||500 bbl||1,000 bbl|
|Ratio to standard contract||1/10||½||1|
Though smaller in contract size, Micro WTI Crude Oil futures provide the same transparency and price discovery as the larger contracts, so investors can trade them with the same strategies they would typically apply to the larger contracts.
The difference is, crude oil investors now have the option of using the Micro contracts to manage their crude oil price exposures by as little as 100 bbl.
More importantly, the initial margin and maintenance margin required to place a trade is proportionally reduced for the Micro contract so investors can trade with a lower capital outlay.
Here’s how its margin requirements compare with the benchmark contract.
|Product Name||Product Code||Contract Size||Initial Margin||Maintenance Margin|
|WTI Crude Oil Futures||CL||1,000 bbl||$5,830||$5,300|
|Micro WTI Crude Oil Futures||MCL||100 bbl||$583||$530|
*Accurate as of May 10, 2021. Please check with your brokers for the exact margin required to trade.
With the latest market volatility and availability of this new market instrument that allows lower entry opportunities for investors, the Micro WTI crude oil futures contract has already recorded trading volumes of more than 1 million contracts on August 6, 2021, in less than a month after its launch.
Shrinking contract sizes to meet bigger needs
In the mid-1990s, the standard futures contract for the S&P 500 index had grown too large and priced out smaller retail investors. Even professional and institutional traders sought ways to trade and hedge with more precision. So in 1997, CME Group launched the very first E-mini futures contract for the S&P 500 index, with a notional value of 50 times the value of the index. That was a fifth the size of the full contract.
The E-mini S&P 500 futures contract quickly gained traction among investors, and bred a whole line of similar e-mini contracts for other commodities, indices, and asset classes. To date, the original E-mini S&P 500 remains one of the most actively traded e-mini futures contracts, overtaking its predecessor in trading volumes in 2009.
Then in 2019, as investor demand for greater granularity in trading and hedging grew louder, CME Group launched Micro e-mini contracts for 4 major equity indices, sized at a tenth of its e-mini contract. The Micro contracts proved to be yet another resounding success, and from that point, Micro futures contracts were expanded to include equity index futures and options, bitcoin, metals, FX, and crude oil.
If history is anything to go by, then this latest Micro WTI Crude Oil Futures contract may well become the next go-to investment vehicle for crude oil investors around the world.