Factbox: Theories behind Monday's shock oil price drop

NEW YORK Tue Sep 18, 2012 4:33pm EDT

NEW YORK (Reuters) - The rapid drop in oil prices over a few minutes on Monday gave rise to several theories as to what spurred the drastic move.

While the U.S. Commodity Futures Trading Commission is looking into the trade plunge -- which knocked more than $3 off the price of oil as volume spiked over a few minutes just before 2 p.m. EDT (1600 GMT) -- traders said it would likely take a long time until the reason behind the drop was uncovered, if ever.

Following is a list of some of the potential causes for the abrupt drop being discussed by traders contacted by Reuters on Tuesday, as well as some reasons why they may not be correct.

ALGO GONE WILD At least once in recent years an algorithmic trading program run amok has caused an abrupt, unexplained move in oil prices - on February 3, 2010, a new trading program unleashed by high-frequency trading firm Infinium Capital Management accidentally sent incorrect buy orders, causing a brief $1 surge in oil prices and landing the firm with a million dollar loss.

In Monday's case, many traders argue that oil prices, which had been climbing toward $120 a barrel for international benchmark Brent, were too high and set for a correction lower. Oil prices were already lower before the big price fall, and after the frenzied trade was over, they recovered only a portion of the losses which occurred during the drop.

If an algorithmic trade were to blame, it may have artificially pushed prices lower temporarily but they would have bounced mostly back up to where they were once the trade was complete, if overall market sentiment had been in favor of higher prices, one trader said.

Instead, U.S. crude oil futures later traded to a new intraday low of $94.65 per barrel, then settled at $96.62. Brent crude oil fell to a low of $111.50 and settled at $113.79 on Monday.

"FAT FINGER" ERROR Occasionally in the increasingly electronic oil markets, a trader may enter an order incorrectly, either offering to sell at a price far below the market or adding an extra zero to a buy or sell order, flooding the market.

However, a close look at the timing of the move show that the price drop did have some momentum, gathering pace for a few minutes before the sharp drop occurred over a brief period. In addition, prices held on to some of the losses before a second period of selling a few minutes later occurred. According to the "fat finger" error theory, this could imply a second big order put in incorrectly, which appears unlikely.

SPR RUMOR Rumors that the Obama administration will release crude oil from the U.S. Strategic Petroleum Reserve in order to lower prices threatening the economy have been tied to at least one sharp downward move over the past month, and traders have said it has weighed on markets on other days.

While some market watchers suggested a rumor that an SPR release was imminent could have caused Monday's move, Reuters could find no evidence of a specific fresh rumor entering the market at the time, and the White House was quick to say they had taken no action or decision.

EUROPEAN RATES FT Alphaville suggested one possibility that the move could have been tied to a story released just minutes before the fall that the European Central Bank could cut its main interest rate and put its deposit rate into negative territory.

Such a move could create an incentive for companies to stockpile crude even when the Brent forward curve is backwardated -- or at least until Brent is more deeply backwardated. The extra inventory would create downward pressure on crude.

LOW LIQUIDITY DUE TO ROSH HASHANAH Analysts suggested trading was thin due to the Jewish holiday. Stops had been set up to cover the holiday trade, and one of them was triggered, causing a drop in the market that then triggered other stops set up at levels close by.

With trading volumes light, there was no liquidity to prevent the losses from cascading and creating a sudden, sharp downward movement lower.

However, a Reuters analysis of trading volumes in the minutes leading up to the crash showed that volume on Monday was actually higher than the average in the same period over the previous seven sessions.

During the previous seven sessions, from the period from 1:30 p.m. EDT (1500 GMT) to 1:50 p.m. an average of 149 contracts changed hands per minute, according to Reuters calculations based on exchange data. On Monday, during the same period, 257 contracts were traded each minute.

(Reporting by Jeanine Prezioso and Matthew Robinson)

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