A single large sell order in the benchmark European Brent oil market, followed by an abrupt U-turn among high-frequency traders, may have caused one of the most abrupt price routs ever, brokers and analysts said on Tuesday.
As the dust settled on Monday's four-minute, nearly $4 plunge, other possible causes such as an erroneous "fat finger" trade, a computer program run amok or a broad, rumor-driven sell-off were set aside in favor of a combination of one big trade - potentially as much as 12 million barrels worth some $1.4 billion - and tens of thousands of computerized orders.
"There was most likely a large fundamental seller in the market yesterday," said Eric Scott Hunsader, Chief Executive of Nanex, a trading consultancy that regularly conducts detailed forensic analysis of erratic market activity.
But assuming a single seller got the ball rolling lower, it was algorithmic traders that almost certainly extended and intensified the decline, causing a 20-fold spike in volume as risk limits or automated price triggers fueled selling.
Prices fell moderately at first, with Brent crude dropping by just 98 cents over the first three minutes. But the sell-off intensified over 46 seconds after 13:53:56 p.m., at which point market-makers may have been forced to liquidate.
"We can see from looking at the tick data that initially the High Frequency market makers were willing to absorb their position around $98 a barrel in U.S. crude," said Hunsader, who examined detailed trading data in the NYMEX market.
Separately, several broker sources said the sell-off originated in the Brent market.
"This created what the CFTC has described in the past as a 'hot potato' event, where the position was rapidly passed on in a way that looks very similar to the equity market 'flash crash' in May 2010."
Talk of more nefarious causes was deemed highly unlikely. High-frequency firms rarely initiate big one-off trades. A mistaken trade execution would likely have provoked an immediate rebound as the seller scrambled to buy back positions.
"Based upon our initial review, it does not appear that a fat finger is the likely cause of the oil price dive yesterday," CFTC commissioner Bart Chilton said in an interview. "We have been poring over the data."
BUT WHY?
What remains unclear, and may not be known for weeks if ever, was who placed the first order that might have set the rout in motion - and why.
Was it a hedge fund in distress, or one that had simply changed its view on prices? An oil trade that spilled over into other commodities, which also fell, or a cross-asset macro-trade? Why would anyone choose one of the most subdued periods of the trading day to execute such a mammoth deal?
Finding the root cause is harder now than before.
Unlike five years ago, when the constant human chatter of the New York oil trading pit would likely have pinpointed a culprit in short order, oil markets are now traded almost wholly electronically, further disguising the participants of a notoriously secretive and opaque marketplace.
For many dealers, no single scenario made sense.
"If it was a single player, why would they be so eager to take profit at that time? Not yesterday, not at 2 o'clock, all of a sudden. That doesn't make sense," said Joseph Genovesi, a veteran crude oil broker with United ICAP in New York.
The Commodity Futures Trading Commission (CFTC) is looking into the drop and is collaborating with the UK's Financial Services Authority (FSA), which has oversight of ICE's Brent market, a source said. It is customary for the CFTC to review irregular trading, but it rarely comments on those enquiries.
CME Group Inc
ICE declined to comment on whether it saw any unusually big orders placed during the period, but said: "Following rumors regarding the SPR, volume was widely distributed and oil prices declined over a period of time. Circuit breakers were not triggered and markets were orderly."
AN ORDERLY 30 SECONDS
Jeff Grossman, president of BRG Brokerage on the NYMEX floor, said some traders believe a single counterparty might have moved to sell 10,000 to 12,000 lots in a single clip - an extraordinarily large order at a time of day when volume is low.
"It was very orderly, but 30 seconds meant a lot yesterday," said Grossman.
The larger question may be why. Sophisticated traders would know that the period of time - around 1:50 p.m. EDT - was a typically low ebb in market liquidity, raising the risk that larger orders could roil prices.
It is in between two periods of relatively higher trade: The Platts half-hour trading "window" for setting European oil prices, which ends at 1530 GMT (11:30 a.m. EDT), and the official close and settlement for NYMEX futures at 2:30 p.m.
Over the preceding six trading days, trading volume in front-month Brent and WTI futures averaged less than 1,000 lots per five-minute period. Until 1:51 p.m., Monday was no different, despite suggestions that the Rosh Hashana holiday might have reduced trading volume and heightened volatility.
But during the five-minute period to 1:55 p.m., volume surged: A total 18,735 lots of Brent and 21,914 of WTI traded in that period, in the absence of any obvious news or headlines.
REMEMBER MAY?
While extraordinary, the event was not without precedent, nor even the most aberrant in recent history. It bears some similar characteristics to the May 5, 2011 slump that drove Brent oil futures down as much as $13 a barrel. Both appeared to be unrelated to news and seemed orderly yet extraordinary. Both defied efforts to make any external sense of things.
In hindsight, the two had another factor in common: Both erupted at a time of intensifying debate over releasing emergency oil stockpiles.
Rumors of a U.S. decision to tap into the strategic petroleum reserve (SPR) was initially posited as a potential cause on Monday. The White House denied any decision had been made. In early May last year, President Barack Obama had just given the nod to seek support from allies to tap into reserves - a decision that would not be public for over a month.
Regardless of the cause, some fear that the growing role of computer-driven traders - now estimated to account for half or more of oil market liquidity - might make these events more common.
"This raises a larger questions about whether these markets continue to fulfill the fundamental purpose - hedge risk and price discovery," said the CFTC's Chilton.
