Rapid plunge in oil futures leaves traders guessing

Written by Reuters | New York/Washington | Updated: Sep 19 2012, 07:56am hrs
Four minutes of hectic high volume trading sheared $4 off the price of oil late Monday and left traders and US regulators hunting for the cause of one of the fastest and most furious energy market routs in recent years.

In the absence of any major headline news that could have explained the drop, which hit both international benchmark Brent crude and US oil futures, traders and analysts speculated it may have been caused by an incorrectly entered trade a fat finger error or a high frequency computer trading program gone awry.

The White House doused market speculation that it was ready to approve an oil release from the US strategic petroleum reserve (SPR) to bring down prices, although it said the option remains on the table.

The kind of speedy price decline that hit oil on Monday is more typically associated with unexpected economic news, such as a dismal US unemployment figure or a surprise production boost by Opec countries. There were no such headlines on Monday.

Federal regulator the Commodity Futures Trading Commission (CFTC) is looking into the price drop, said commissioner Scott OMalia, and has contacted exchange operators the CME Group and the IntercontinentalExchange.

Our people are aware of it, said OMalia. They are going to get to the bottom of it.

ICEs Front-month November Brent crude, which had opened at $116.67 a barrel, at one point fell by as much as $5.17 a barrel to $111.50. US. crude futures also fell sharply. In the minute before that plunge, 151 lots of front-month October US crude exchanged hands on the New York Mercantile Exchange. Three minutes later, volume spiked nearly a hundredfold, to above 13,000 lots in one minute.

European benchmark Brent began to recover after its sharp drop, and later settled down $2.87 on the day at $113.79 a barrel. US crude settled at $96.62 a barrel, up from earlier lows of $94.65.

All of a sudden it just dropped, then it snapped right back up. Then you had 50- to 75-cent moves, so you saw guys just stay away from it. From there it was just a barrage of rumors, said John Woods, president of JJ Woods & Associates, a brokerage on the NYMEX floor.

Everybody was asking the same thing: What the hell is going on here

Some analysts say that rapid and sharp price moves over a

very short period of time and with no clear cause are becoming more frequent. On May 5, 2011, US oil futures fell by as much as $13 a barrel and settled down by around $10 a barrel. Many traders then blamed waves of computer-driven selling by banks and hedge funds.

The CME Group, which operated the New York Mercantile Exchange, said it had not experienced any technical failures and did not plan to cancel any oil market trades from Mondays drop.

It said NYMEX energy markets including crude, gasoline and heating oil futures saw a coordinated selloff of a prolonged duration of 30 minutes beginning around 1:50 pm in New York.

The Intercontinental Exchange, whose ICE platform is the biggest venue for trading Brent Futures, declined comment.

Traders and energy analysts speculated about a fat finger incident on Monday, but Reuters was not able to identify any potential culprit.

Another conjecture was a selloff led by algorithms programmed into super-computers at banks and hedge funds. That could have been triggered by a breach in a technical price threshold, and exacerbated by low trading volume. Many traders were away on Monday to celebrate Rosh Hashanah.

One veteran energy market risk manager said Mondays abrupt crude price fall was the fastest move I've ever seen. I think it was too fast to be anything but HFT (high-frequency trading) or other algos (algorithmic traders), said John Gretzinger at INTL-FCStone in Kansas City.

Regulators have been closely examining high-frequency trading which accounts for roughly half of both US equity volume and commodity futures trading after high-profile glitches roiled markets in the past.

The May 2010 flash crash briefly wiped out $1 trillion in paper value from the stock market. Regulators have said the algorithms behind rapid-fire trading were a factor but did not cause the crash.

More recently, in August, a software glitch at Knight Capital Group flooded the New York Stock Exchange with unintended orders for dozens of stocks, boosting some shares by more than 100% and leaving the company with a crippling $440 million loss. The firm was forced to seek a financing deal to stay afloat.