Crude oil slide puzzles nervous U.S. market

NEW YORK Wed Feb 20, 2013 10:14pm EST

NEW YORK Feb 20 (Reuters) - A steep decline in crude oil prices on Wednesday set off what is fast becoming a familiar debate on Wall Street: was it man or machine?

The price of U.S. benchmark crude plummeted about $2 per barrel in morning trading, at one point falling by 42 cents in just two seconds as more than two million barrels worth of crude oil contracts changed hands, a Reuters analysis of exchange data shows.

Then something strange happened: the market for the most heavily-traded U.S. crude oil contract went quiet. For nearly ten seconds, not one contract crossed the ticker tape, intensifying the panic already gripping traders scrambling to find what had set off the decline.

It was by no means a huge sell-off by historical standards. In early May of 2011, U.S. crude prices collapsed by 10 dollars a barrel over the course of one wild trading session.

Still, the speed of the $2 dollar slide illustrates how quickly the oil market can turn, surprising traders after months of relatively small price moves and low volatility.

The episode also marks the latest in a spate of hiccups which have plagued market operators, prompting exchanges to put in place plans for halting trading during abnormal trading activity.

A spokesman for CME Group said the exchange did not halt trading in crude oil and that the markets functioned properly throughout the day.

But that has prompted even more questions about whether an avalanche of computer-driven trading or human error disrupted Wednesday morning's session.

"We have a real mystery on our hands," said Eric Hunsader, founder of Nanex, a Winnetka, Illinois-based trading software company that tracks market activity. Nanex also noticed the spike in volume and the ten second pause shortly after 11 a.m. New York time (1600 GMT).

The affected trading instrument, an April contract for delivery of 1,000 barrels of U.S. crude oil, saw nearly two million barrels' worth of trading volume in a one-second interval at around 11:01 a.m., Reuters found. Volume had averaged about 13,000 barrels per second over the previous trading hour.

The price of the contract fell from $95.47 to $95.05 just two seconds later. The price then ticked higher, to $95.16, before the market froze for about ten seconds. Trades reappeared shortly before the minute was out, and the market carried on with the volatile trading session.

U.S. April crude fell $1.88 to finish the day at $95.22 a barrel, having slumped as low as $94.21, it's steepest daily fall so far this year.

In the confusion, a rumor had spread that the morning's precipitous decline had been sparked by a large hedge fund rapidly liquidating its positions.

Automated and algorithmic trading by hedge funds and big banks has grown rapidly in recent years. Supporters say it adds much-needed liquidity to commodity markets, but critics say it can cause violent, sometimes inexplicable moves in key markets.

Reuters was unable to independently verify the rumor of the rapid-fire hedge fund liquidation, and many market observers brushed it off as just that.

"You hear that every time there's a big move in anything," said Walter Zimmermann, chief technical analyst at United-Icap in New Jersey. "Hedge funds tend to all get into the same trade at the same time and out of the same trade at the same time."

Instead, a rising dollar and a falling stock market were to blame for oil's decline, Zimmermann said.

Other sources pinned the decline on expectations that Saudi Arabia intends to raise its oil production in the second quarter and a comment by a Western diplomat that major powers are ready to make "a substantial and serious offer" to Iran during talks over its nuclear program next week.

Still, Hunsader of Nanex, the trading software firm, said the data is indicative of a major seller in the market.

"The one thing that fits from everything that we see is that somebody really wanted to sell a lot of crude oil," Hunsader said.