For Release: February 5, 2007
Washington, D.C. – The Commodity Futures Trading Commission’s (CFTC) Office of the Chief Economist today released a study titled “Market Growth, Trader Participation and Pricing in Energy Futures Markets.” This study provides an analysis of the composition of traders across different energy futures contract maturities and addresses questions relating to price discovery in these markets. Specifically,
The authors use CFTC data on futures trader positions to document major changes in the size and term structure of the U.S. crude oil (WTI) futures market. The authors find that as recently as 2000 trading activity in this market was heavily concentrated in nearby contracts. Since then, overall open interest has grown two-fold, with trader activity at the back end of the term structure increasing more than twice as much as the market as a whole.
The market growth in long-term (more than three years) positions generally started in 2004, which coincides with the growth in participation by commodity swap dealers.
An analysis of the composition of traders participating in the market shows that almost all large-trader categories (commodity swap dealers and arbitrageurs; hedge funds; commercial dealers; and commercial producers) now carry aggregate net positions in long-term contracts comparable in magnitude to the size of their net positions in short-term (less than three months) contracts prior to 2003. Importantly, for the first time, the authors document the diversity of the participants with different objectives trading at the back of the curve.
The authors explain that price discovery and risk transfer are critical functions performed by futures markets. The closer correlation between the prices, the more efficient transmission of information, and improved hedging opportunities. In the context of this study, the authors find that prices of one-year and two-year futures became strongly linked with the price of the near-month WTI futures for the first time in 2004. The authors provide evidence that the pricing convergence is linked mainly to commodity swap dealers, but hedge funds, floor brokers, dealer/merchants and manufacturers and producers also contributing significantly to price discovery.
The authors also demonstrate how increased participation by non-traditional commercial traders and speculators can enhance market quality in commodity markets.
The results have significant implications for those interested in price discovery in WTI futures, the opportunity to construct hedges in distant months with crude oil futures, with the assurance that there are diverse participants providing liquidity in distant month contracts. The study will also be of general interest to those interested in the quality of information derived from futures prices across the term structure.
Contributing to this study were Drs. Michael S. Haigh, Jeffrey H. Harris, James A. Overdahl and Michel A. Robe.
R. David Gary
Last Updated: March 18, 2007