Market growth, trader participation and pricing in energy future markets

We use a unique dataset on futures trader positions to document major changes in the size and term structure of the U.S. crude oil futures market. We show that, as recently as 2000 trading activity in this market was heavily concentrated at the near end of the maturity spectrum. Since then, overall open interest has grown two-fold, with trader activity at the back end of the maturity spectrum increasing over twice as much as the market as a whole. The market growth in long-term (>3 years) positions generally started in 2004, which coincides with the growth in participation by commodity swap dealers in the futures markets. 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 shortterm (<3 months) contracts prior to 2003. Amidst this market growth, the prices of one-year and two-year futures became co-integrated with the price of the near-month futures for the first time in 2004. We provide evidence that the pricing convergence is linked to the growth in futures trading by commodity swap dealers and arbitrageurs. Our results have significant implications for those interested in the effectiveness of hedges constructed with long-term crude oil futures contracts and for those interested in the quality of information contained in futures prices across the term structure.