Publications: Notes at the Margin

US Oil Minnows' Undercapitalization Threat to Markets (November 14, 2022)

 

The heating oil futures contract created by the New York Mercantile Exchange, now owned by CME and called the ultra-low-sulfur-diesel (ULSD) contract, was the first successful petroleum futures contract. Oil firms, traders, and speculators used it to hedge oil risk until the WTI and Brent futures contracts became successful.

 

The ULSD contract may now be on the verge of failure. Open interest has declined sharply. The deeper problem, however, is that the price quotes in New York for diesel bear no relationship to its value in other markets. Consequently, the contract may become useless as a hedging vehicle. Meanwhile, those short the December ULSD contract might lose more than $2.6 billion at the end of the month.

 

The cause of the contract failure lies with firms like Global Partners that supply the US northeast market. These companies, like many energy firms in Europe, are too financially weak to operate in the current disrupted market. In short, they are “oil minnows” compared to the major firm “whales.” The minnows’ weak balance sheets prevent them from holding inventories sufficient to meet expected consumer demand. Their low stocks of heating oil and low-sulfur diesel have pushed the market into deep backwardation, which in turn has driven cash prices in New York Harbor and New England to artificially high levels. The artificial New York Harbor cash prices render the CME ULSD contract less useful, perhaps even irrelevant, for traders everywhere except in New York and New England.

 

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