Special Report: Celebrating 40 Years of Crude Oil Futures

NYMEX:CL1!   Light Crude Oil Futures
NYMEX: WTI Crude Oil ( CL1! )
On March 30, 1983, New York Mercantile Exchange (NYMEX) launched futures contract on WTI crude oil. This marked the beginning of an era of energy futures.

WTI is now the most liquid commodity futures contract in the world. It’s 1.7 million daily volume is equivalent to 1.7 billion barrels of crude oil and $125 billion in notional value. For comparison, global oil production was 89.9 million barrels per day in 2021.

Looking back at 1983, exactly 40 years ago:
• NYMEX was primarily a marketplace for agricultural commodities, with Maine Potato Futures being its biggest contract;
• NYMEX was a small Exchange with 816 members, mainly local traders and brokers;
• Known as Black Gold, crude oil was a strategic commodity regulated by governments and monopolized by the Big Oil, the so-called “Seven Sisters”;
• Pricing of crude oil was not a function of free market but controlled by the Organization of Petroleum Export Countries (OPEC), an oil cartel.

The birth of crude oil futures contract was a remarkable story of financial innovation and great vision. Facing a “Mission Impossible”, NYMEX successfully pulled it off. At the helm of the century-old Exchange was Michel Marks, its 33-year-old Chairman, and John E. Treat, the 37-year-old NYMEX President.

The “Accidental Chairman”
Michel Marks came from a long-time NYMEX member family. His father, Francis Q. Marks, was a trading pit icon and influential member. Since high school, the younger Marks worked as a runner on the trading pit for his family business. After receiving an Economics degree from Princeton University, Michel Marks returned to NYMEX as a full-time member, trading platinum and potatoes.

In 1977, the entire NYMEX board of directors resigned, taking responsibility for the Potato Futures default from the prior year. Michel Marks was elected Vice Chairman of the new Board. He was 27 years old.

One year later, the Chairman at the time suffered a stroke. Michel Marks replaced him as the new NYMEX Chairman. At 28, he’s the youngest leader of any Exchange in the 175-year history of modern futures industry.

White House Energy Advisor
John E. Treat served in the US Navy in the Middle East and later worked as an international affairs consultant in the region. He received an Economics degree in Princeton and a master’s degree in international relations from John Hopkins.

During the Carter Administration (1977-1981), Treat worked at the US Department of Energy. He served as Deputy Assistant Secretary for International Affairs and sat on the National Security Council and the Federal Energy Administration. In his capacity, Treat was at the center of the formation of US energy policy.

After President Carter lost his reelection bid, Treat left Washington in 1981. At the time, NYMEX was exploring new contracts outside of agricultural commodities. One possible direction was the energy sector, where NYMEX previously listed a Heating Oil contract with little traction in the market. With his strong background, Treat was recruited by NYMEX as a senior vice president.

A year later, after then President Richard Leone resigned, Treat was nominated by Chairman Marks to become NYMEX President. He was 36 years old.

The Birth of WTI Crude Oil Futures
In 1979, the Islamic Revolution in Iran overthrew the Pahlavi dynasty and established the Islamic Republic of Iran, led by Shiite spiritual leader Ayatollah Khomeini.

Shortly after, the Iran-Iraq War broke out. Daily production of crude oil fell sharply, and the price of crude oil rose from $14 to $35 per barrel. This event was known as the second oil crisis. It triggered a global economic recession, with U.S. GDP falling by 3 percent.

After President Reagan took office in 1981, he introduced a series of new policies, known as Reaganomics, to boost the U.S. economy. The four pillars that represent Reaganomics were reducing the growth of government spending, reducing federal income taxes and capital gains taxes, reducing government regulation, and tightening the money supply to reduce inflation.

In terms of energy policy, the Reagan administration relaxed government regulations on domestic oil and gas exploration and relaxed the price of natural gas.

NYMEX President John Treat sensed that the time was ripe for energy futures. He formed an Advisory Committee to conduct a feasibility study on the listing of crude oil futures. His strategic initiative received the backing of Chairman Michel Marks, who in turn gathered the support of the full NYMEX membership.

Arnold Safir, an economist on the advisory board, led the contract design of WTI crude oil futures. The underlying commodity is West Texas Intermediate produced in Cushing, Oklahoma. The delivery location was chosen for the convenience of domestic oil refineries. WTI oil contains fewer impurities, which results in lower processing costs. US refineries prefer to use WTI over the heavier Gulf oil.

WTI trading code is CL, the abbreviation of Crude Light. Contract size is 1,000 barrels of crude oil. At $73/barrel, each contract is worth $73,000. Due to the profound impact of crude oil on world economy, NYMEX lists contracts covering a nine-year period.

On March 29, 1983, the CFTC approved NYMEX's application. The next day, WTI crude oil futures traded on the NYMEX floor for the first time.

Competing for the Pricing Power
Now that crude oil futures were listed. Initially, only NYMEX members and speculators were trading the contracts. All the oil industry giants sat on the sidelines.

John Treat knew that without their participation, the futures market could not have meaningful impact on the oil market, not to mention a pricing power over crude oil.

In early 1980s, the global oil market was monopolized by seven Western oil companies, known as the "Seven Sisters". Together, they control nearly one-third of global oil and gas production and more than one-third of oil and gas reserves.
1) Standard Oil of New Jersey, later became Exxon;
2) Standard Oil of New York, later became Mobil Oil Company; It merged with Exxon in 1998 to form ExxonMobil;
3) Standard Oil of California, later became Chevron; It took over Texaco in 2001, and the combined company is still named Chevron;
4) Texaco, collapsed in 2001 and was taken over by Chevron;
5) Gulf Oil, which was acquired by Chevron in 1984;
6) British Persian Oil Company, operating in Iran, withdrew after the Iranian Revolution and then fully operated the North Sea oil fields, later British Petroleum ("BP");
7) Shell, an Anglo-Dutch joint venture.

Treat's background as President Carter's energy adviser played a key role. After nearly a year of hard work, the first Big Oil entered the NYMEX crude oil trading floor. However, it was not until five years later that all Seven Sisters became NYMEX members.

OPEC producers tried to boycott the crude oil futures market. However, as trading volume grew, they eventually gave in, first by Venezuela and then the oil producers in the Middle East.

Interestingly, the Middle Eastern oil producers started out by trading COMEX gold futures, probably as a hedge against oil prices. Gold has been a significant part in the Middle Eastern culture for long. As the main buyers of gold, the Arabs buy more gold when their pockets are filled with rising oil prices, and conversely, they sell gold when oil revenues fall and their ability to buy gold decreases.

With the participation of Big Oil and OPEC, coupled with an active crude oil options market, crude oil pricing power has shifted from the Middle East to NYMEX's trading floor by the end of the 1980s. WTI has also become a globally recognized benchmark for crude oil prices.

Happy Trading.

*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.

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Jim W. Huang, CFA

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