Distortionary effect of trading activity in NYMEX crude oil futures market: post crisis

• Published date: 01 March 2017
• Date: 01 March 2017
• Author: Afshin Javan,Mohammad Amin Naderian
• DOI: http://doi.org/10.1111/opec.12092

Distortionary effect of trading activity in

NYMEX crude oil futures market: post crisis

Mohammad Amin Naderian* and Afshin Javan**

*Ministry of Petroleum, Tehran, Iran. Email: ma.naderian@mop.ir

**OPEC Secretariat, Vienna, Austria. Email: ajavan@opec.org

Abstract

In light of the ongoing growth in hedge fund and investment bank exposure in the NYMEX WTI

crude oil futures market since the global financial crisis, we have applied linear causality tests to

identify if each individual trader group in the disaggregated commitment of trader’s report have

prior destabilising effect on market return (the rate of change in crude oil prices), price volatility

and the futures-spot spread in the period 2009–2015. Consistent with the CFTC’s disaggregated

classification system, the trader groups considered are physical participants, swap dealers and

money managers. In order to capture the nonlinear causality relationship, the Diks and Panchenko

(Journal of Economic Dynamics and Control, 2006, 30, 1647) non-parametric causality approach

has also been utilised. Test results demonstrate that changes in the net positions of physical

participants has both linear and nonlinear positive causality on expected market return, as well as

feedback loops. Change in swap dealers net position, however, only have linear bidirectional

causality with market return and futures-spot spread, with unidirectional Granger causality with

price volatility. While money managers were not price trend followers, they have preceding

influence on market risk and return dynamics. It can be concluded that swap dealers and money

managers have distortionary effect on market return, price volatility and the futures-spot spread.

Instead, Physical participants distortionary effect is restricted to market return.

1. Introduction

Substantialgrowth in the trading activity and open interest volume after2003 due to greater

participation by hedge funds, insurance companies, and retail investors in futures and

derivative markets is a major structural change in the crude oil market. Better performance

of commodities returns compared to other traditional categories, like stocks and bonds,

during periods of rising inflation stirred investors to use a diversified basket of commodity

futures to hedgetheir positions. New financialproducts allow institutions and individuals to

invest in commodities through long-only index funds, over the counter (OTC) swap

agreements, exchange traded funds (ETF) and other structured products. In the new

JEL classification: C3, G14, G1.

©2017 Organization of the Petroleum Exporting Countries. Published by John Wiley & Sons Ltd, 9600 Garsington

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environment, oil was no longer considered an industrial commodity, but also as a financial

asset (Jalali Naini, 2009). The new instruments create a situation where institutional

investors could more easily allocate large pools of capital into the commodity market, not

only through index funds, but also through other financial products.

1

A rise in the participation of new commodity index investors not only lead to a sharp

increase in open interest volumes in the WTI futures market, but also to a shift in the mix of

market participants with increasing share of non-commercial firms (Figure 1). These

developments resulted in greater spot price volatility and risk premium (Tang and Xiong,

2010; Hamilton and Wu, 2014; Hamilton and Wu, 2015), as well as increased price movement

between crude oil and financial assets

2

(Figure 2) and between crude oil and non-energy

commodities (Buyuksahin and Robe, 2014; Silvennoinen and Thorp, 2016) (Figure 3).

On the positive side, financialisation reduces hedging costs and improves risk

sharing by bringing a large number of financial investors to the long side. In fact,

commodity index investors supply liquidity to physical hedgers to accommodate their

hedging demand with lower costs while they could also consume the market liquidity

when they are trading for their own (Cheng and Xiong, 2014). Therefore, increased

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Trade acvity (Non-commercials) Trade acvity (Commercials) Trade acvity (Non-reportables)

Figure 1 Weekly t rading activity of individual traders in WTI crude oil futures market, 2000–2016.

[Colour figure can be viewed at wileyonlinelibrary.com]

Note: The trading activity index (TOI) is measured as the percent of total open interest volume

held by each CFTC trader calculation in aggregated COT report.

OPEC Energy Review March 2017 ©2017 Organization of the Petroleum Exporting Countries

24 Mohammad Amin Naderian and Afshin Javan