What are Oil futures

Crude oil is an indispensable fuel source and most versatile chemical raw material. It is the very foundation of the modern way of life as we know it and is virtually in every article and equipment we use today. And while it amounts to a third of the entire energy requirement the process of discovery, extraction, processing, and transportation of crude oil is long and complicated. Even things like storage of crude oil and its by-products are ever evolving challenges that increase in difficulties with constant change in availability in storage and refining capacity. 

Crude Oil Futures in India

In India crude oil futures are listed on Multi Commodity Exchange and are traded between 9:00 am to 5:00 pm from Monday to Friday.

The contract is for 100 barrels i.e. lot size is 100, and price is quoted in terms of price per barrel. Therefore, if the price of barrel is ₹6,815 then the value of contract would be (₹6,815*100) ₹6,81,500.

The tick size of the crude oil futures contract is ₹1, meaning every price change will at least be ₹1 and would impact mark-to-market by ₹100. The exchange has stipulated a minimum margin of 10% of contract value. However, the SPAN margin mechanism is also deployed. The exchange charges a minimum of 10% of contract value or SPAN, whichever is higher.

The Exchange has implemented a narrower daily price limit slab of 4%. Whenever this narrower slab is breached, the relaxation will be allowed for additional 2% without any cooling off period in the trade. In case the daily price limit of (4% + 2%) 6% is also breached, then after a cooling off period of 15 minutes, the daily price limit will be relaxed another 3% i.e. upto 9%. In case price movement in international markets is more than the maximum daily price limit (currently 9%), the same may be further relaxed in steps of 3% and will be informed to the Regulator immediately.

In case of additional volatility, an additional margin (on both buy & sell side) and/ or special margin (on either buy or sell side) at such a percentage, as deemed fit, will be imposed in respect of all outstanding positions. The exchanges can charge an “Extreme loss margin” of additional 1%.

NYMEX crude futures

MCX crude oil contract is directly based on the NYMEX WTI (Western Texas Intermediary) commonly referred to as “Light Sweet” crude oil. WTI price is quoted in USD per barrel and MCX crude oil futures being a “derived” and a  “mirror” contract, simply assumes conversion of USD to INR. The USD/INR rates are based upon the RBI published spot rate.

Therefore, if NYMEX Crude oil is trading at $ 83.00/barrel and USD/INR is trading at 81.55, the resulting MCX crude oil will be priced at (83.5 * 81.55) ₹6,810/barrel. 

On the international exchanges platform crude oil futures are traded for almost 23 hours a day. 

Participants in crude oil futures

Crude oil futures usually have a high liquidity and are frequently used by market participants and actual users like oil refineries and oil companies like ONGC, HPCL and others. The end users of crude oil by-products like paint companies and tyre companies also form a significant base of crude oil futures trading like Asia.  

It is important to remember that the crude oil represents the input cost for the refineries, and the by-products are the revenue generators. Therefore, refineries always take a long position in crude oil derivatives to hedge the cost and shall always take a short position in by-products like gasoline, diesel and jet-kero, etc. There are contracts listed on NYMEX that represent “crude oil to gasoline distillation spread” more commonly known as Crack spread (cracking is termed used to distill crude oil into by-products).

Crude oil futures are also traded alongside Natural gas futures as a ratio spread. As both of them represent the major component of the energy basket, they are likely to move in tandem. The commodity specific demand and supply, seasonality, production capacity do play a role in pricing. But overall, the energy basket is supposed to move in sync, and therefore the lagging commodity will catch up to close the gap.

Another possibility with Crude oil futures is trading the spread between the calendar months. Crude oil is generally priced in backwardation i.e. the near month contract is more expensive than the next month, and the next month is more expensive than the far month. The discounted next month contract to the near month does not mean that there is decline in demand. But the near month contract premium represents the urgency for immediate delivery.

The crude oil futures calendar spreads are generally traded in backwardation but the discount in next month can change into premium when unforeseen events occur. For Eg: During the first Covid-19 worldwide travel ban and lockdown in major countries prompted the near month oil contract to nose dive to $ 0.20 near zero levels, while the far month was trading at sub $ 10.00 levels.