A black swan situation and its repercussions
The most recent events concerning the raging Corona pandemic have kept the global markets breathless. The preventive measures against the spread of this new virus have inflicted economic repercussions on the gastronomy and hotel business, retailers, automobile producers and airlines. But they are not alone. Commodities traders are also affected, especially those with businesses closely linked to the price of crude oil because it has suffered its worst plunge since the beginning of futures trading. The reason for this is the failed OPEC negotiations on output, a reduced purchase volume because of economic limitations and a lack of storage capacities for crude oil if output is kept up. Traders and speculators are desperately trying to benefit from the falling prices for crude by getting rid of expensive crude oil contracts. This brought about a further crumbling of prices for crude oil, thus causing a so-called super contango in the oil market. On 20 April 2020, this caused the oil price for West Texas Intermediate (WTI) to drop for the very first time in the history of crude oil futures to USD -37.63 per barrel for May contracts. This black swan event1 (partly caused by a technical effect) may have taken some market participants completely by surprise.
Black swans are highly unlikely events which are practically impossible to predict, but if they occur, will have a massive economic impact. Such events demonstrate the limits in predictive abilities of even the most complex forecasting models.
Figure: Super contango before May 20 Futures expired (Source: CME, 21 April 2020)
Just because black swan events cannot be foreseen, they should never be dismissed. The current market situation has raised concerns among Treasury department heads regarding their risk management strategies, methods and processes used so far and made them question the design of their risk cycle and its capacity to mitigate such uncertainties in the long term. Black swan events may be included as extreme stress scenarios. The specific triggering event is in fact irrelevant but what is important is assessing the impact of such an event on the company’s KPIs. Pandemics, natural catastrophes, political upheaval and regulations, financial market crashes, technical disruption, reputational damages and other events have been sufficiently frequent over the past years to be able to assess the possible consequences of a severe slump in sales or the explosion of costs on the company’s financial and profitability situation.
The following questions (which should be part of an effective risk management in any case) are crucial:
The massive slump in crude oil prices has far-reaching consequences for industries along the value chain. If looking at the trade in crude oil, companies (and their treasury departments) acting in this sector will be confronted with the following problems:
Companies should use the crisis to harden themselves against further crises. Indeed, a next super contango may be just around the corner – e.g. when June 20 futures expire. The following could be decisive:
In the end, such events may be to the benefit of the treasury because they help demonstrate to Management and to cost controlling the advantages of an effective and comprehensive risk management for risks related to market price, liquidity and default risks thus enabling you to receive the budget required for this. On the other hand, the next time such a crisis arises, treasurers that are not sufficiently prepared may be reproached as not having learned from the past and being mere fair-weather treasurers.
Source: KPMG Corporate Treasury News, Edition 100, April 2020
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1 The term was coined by Nassim Taleb and his book, The Black Swan: The Impact Of The Highly Improbable (Penguin, 2008)
2 Fair Value through Other Comprehensive Income
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