On April 20, 2020, international oil markets witnessed a remarkable event: negative prompt-month NYMEX crude oil prices. Negative prices used to be held to the realm of model validation—a theoretical construct to help define the robustness of quantitative tools, but not necessarily a practical condition for which to plan. Now that the practical condition exists, oil market participants are working to adapt their operations to the possibility of extreme prices.
In addition, extreme price movements tend to draw the attention of regulators. Market participants should prepare for regulatory inquiry and potential actions. For example:
- Regulators may pursue market manipulation investigations, potential new rules and safeguards, additional regulatory reporting frameworks, or comprehensive studies to better understand extreme price movement factors;
- Global oil exchanges may look into future safeguards and index construction if market participants push for pricing mechanisms that strike the balance between physical markets and financial stability; and
- Given the impact on tax revenue to producing states, it would be reasonable to expect state government inquiries.
How can your company adapt practices and capabilities to a new market condition?
Some forward-thinking organizations are already taking action, and companies across the oil value chain should consider a response which fits their operating and stakeholder needs.
Transaction workflows: Companies with trading and optimization functions may want to conduct comprehensive reviews of their trading workflows and control infrastructures to improve their ability to transact in stressed environments.
Proactive compliance: Compliance entities should consider internal preparation ahead of potential regulatory inquiries, as well as analyzing trade-day data to look for new ways to adapt to extreme market action.
Hedging strategy: E&P companies may want to adapt hedging strategies to incorporate negative prices, they may want to consider the costs and benefits of monetizing extreme hedge gains, and they may wish to re-visit forecasting and planning methodologies.
Risk modeling: Companies may wish to investigate new risk metrics and option pricing models which account for negative prices. They may also focus their big-data capabilities on developing early-warning indicators based on large data sets.
Credit management: Market participants with commodity-based collateral provisions may consider new trigger language and security provisions to protect against collateral erosion.
Risk intelligence: Oil market participants should consider revising their stress-testing and scenario analysis regimes. In addition, companies may consider enhancing risk group capabilities to become a trusted partner and advisor during a crisis.
KPMG can help
KPMG’s trading operations group has spent the past twenty years designing, deploying, and improving operating models and risk management capabilities for companies transacting in the oil markets. Our clients span the entire energy value chain, providing us with a broad base for external perspective and insights into better ways of working. As you think through your approach to the new pricing reality, KPMG can help you accelerate the process.
Our oil and gas team advises large and diverse companies around the world, including integrated oil companies, independents, refining and oil service firms, and national oil companies. Our industry-leading approach focuses on helping companies extract value from their commercial and risk operations while balancing risks against dynamic markets. Our capabilities includes tools, templates and techniques that allow us the ability to move faster, with greater confidence and less disruption to the organization.
Explore these concerns and potential actions more deeply in our article below.