Today, the price of oil is no mystery. And the ability to manage the risk of a commodity that underpins the global economy is also well established.
It’s all thanks to the unlikely debut of WTI Crude Oil futures in 1983, a contract that continues to exert its influence globally — despite being well past its first blush of youth.
“Since that launch 40 years ago, WTI has established itself as the most significant commodity contract on the planet,” said Owain Johnson, CME Group’s head of research and product development. “Changes in the price of WTI can literally move economies.”
And to think it almost didn’t see the light of day.
1983 marked a turning point for crude markets, even though the contract wasn’t met with anywhere near the same excitement as other events that year, such as the release of Michael Jackson’s Thriller album and Nintendo’s game console.
"The World Needed It"
That year, the oil market was mostly in freefall, with Iraq and Iran at war and OPEC finding its footing. With this stormy backdrop, visionaries at NYMEX, now part of CME Group, wanted to establish a transparent market for crude oil where global market participants could come to manage the risk that defined the market.
“Let’s face it: there were no oil markets, technically,” said Thomas McMahon, one of the first traders of the contract. “The idea of crude oil futures was really one where ‘hey, the world needed it.’ That was the thought process. But it was really ‘how do we do it?’”
The 1970s marked the dawn of the spot market in crude oil, which reflected a desire to break away from the pricing regime of the previous 50 years – fixed prices by oil producers. Then, with the launch of WTI futures in 1983, came a new era for price discovery.
“The futures contract was the dawn of the derivative market in crude oil,” said Peter Keavey, CME Group head of energy and environmental products. “It was a revolution in pricing from producer-controlled pricing to free market pricing.”
“There was previously no ability to mitigate risk in the derivatives space, and there was no way for investors to get exposure to the oil market apart from buying oil company stock,” said Keavey. “You had to bring users into the market. That was why the launch of WTI needed to happen.”
The contract faced a series of challenges in the market, but in time was widely adopted.
“The truth of the matter is, it was going to bring transparency. So it was the transparency that basically drove a lot of people in the industry to support the contract,” said John Krus, who was on the original NYMEX committee that built the contract and who is now president of JSK Holdings Inc., a Houston consulting firm. “And the rest is history. It pretty well took off and there was lots of liquidity.”
The WTI committee that included Krus decided on the storage hub at Cushing, Oklahoma, as the delivery point for WTI. When WTI futures were first listed in 1983, Cushing was already a vibrant hub for cash market trading of crude oil, with a network of pipelines, refineries and storage terminals: the obvious choice for the delivery point.
Today, Cushing has grown to become the key nexus for the global crude oil market, with over 30 inbound and outbound pipelines and 16 major storage terminals.
According to the U.S. Energy Information Administration (EIA) as of March 2022, the working storage capacity in Cushing is 78 million barrels, with 94 million barrels of total shell capacity.
“They call it the pipeline crossroads of the world for good reason. It is by far the largest concentrated storage facility,” said Keavey.
Early Stress Tests
3,000 contracts traded in the first month after the launch of WTI, and a year later, trading volume would top 100,000 contracts a month, according to CME Group data. As WTI proved its worth, volumes ramped up even more, topping two million contracts per month by the end of the 1980s.
The crude futures contract was barely three years old when it faced a big test. Oil prices were in freefall after then Saudi Oil Minister Sheikh Ahmed Yamani revealed the Kingdom's practice of netback pricing, which guaranteed buyers a certain refining margin.
“It was April 1986 when the netback deals crushed the crude market,” recalled McMahon. “Brent hadn't launched yet, so we were the only open market. I remember in two days we went from like 34 bucks to nine bucks. I remember the second day it opened like 24 and paid down to nine. I had never seen anything like it, and I had been running in commodity markets for years.”
Amid the chaos, McMahon said the futures contract proved its worth as a risk management tool and achieved a “global buy-in.”
"Literally, it was that simple. When they needed us traders, we proved we could be there. We gave them liquidity where they hadn’t seen it previously.”
“The world needed a crude oil futures contract because in order to scale the market, in order to allocate oil correctly between all the suppliers and consumers, you have to have free market pricing in order for industry to grow and allocate that product properly,” said Keavey.
“You had to bring users into the market. That was why the launch of WTI needed to happen.”
- Peter Keavey
It was another, more notable event, that brought increased attention to oil markets. The first Gulf War was what Keavey described as “the first true stress event for WTI. That was a major event in oil history. Even more than ’86.”
It was an example of another key attribute of WTI – providing a price signal. “The price signal allows oil users to scale back use, and signals to producers to increase or reduce supply to maintain balance in the market. It does that in normal times and during stressful times.”
Not Just About Trading Oil
For his part, McMahon is in awe of how the contract became enmeshed in the broader economy. “It's not just about trading oil. It has priced multiple industries.”
Krus also became a believer because of the volumes the contract attracted. “There's three things that make a contract work, and it’s liquidity, liquidity and liquidity.”
The WTI contract over time faced a string of geopolitical events that took aim at oil markets, including a second Gulf war, the oil price hike that helped tip the world into recession in 2008, and most recently, the conflict in Ukraine.
Through it all, growth in WTI futures surged. “In recent years, we have seen plenty of trading sessions when WTI trades over a million contracts per day and even more,” said CME Group’s Johnson.
The activity highlights how the WTI contract has grown from its humble beginnings to a pivotal benchmark that is deeply woven into the fabric of everyday lives.
Said McMahon: “Because the downstream relationship, the power, energy, and transportation is in everybody's lives — whether you're a small business operator or you've got to drive your kids to school every morning. The cost of energy became embedded in our lives. WTI represents that.”
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