Growth of WTI Crude Oil Futures Liquidity in the Forward Curve

  • 10 Apr 2017
  • By Elizabeth Hui, Qifan Wu and Ricky Li
  • Topics: Energy

Liquidity in WTI long-term maturity contracts has been rising steadily since 2013. The annualized year-over-year spread tightened by 20%, and order quantity grew more than 40%. Concurrently, volume and open interest soared during the same period. Liquidity in energy futures trading has traditionally been prevalent in the spot month and in near term contracts. As the contract term moves further forward, liquidity tends to decrease as fewer companies manage their long term risk. Being one of the most liquid crude oil futures contracts, WTI’s short-term maturity contracts are extremely liquid from the spot month through the first year. Recently, there has been increasing interest in the liquidity of the longer maturity contracts that are two and three years forward. The liquidity in these contracts is crucial for companies to manage their risk in efforts to meet their long term, strategic, and operational goals.

HISTORIC VOLUME AND OPEN INTEREST

WTI has become the global price leader given the growth in U.S. production over the past five years1, while oil producers in the North Sea struggle to produce crude oil in a sustained low price environment. With the lifting of U.S. export ban and greater market efficiencies, WTI has become the leading indicator for price discovery in the global crude oil market.

In 2016, the NYMEX Light Sweet Crude Oil Futures contract saw strong volumes which reflected higher levels of volatility  in crude oil and refined products. According to Exchange data, NYMEX Light Sweet Crude Oil Futures average daily volume reached an all-time high with a record of 1,303,553 contracts in November 2016. Furthermore, open interest also reached an all-time high of 2,074,018 outstanding contracts.

Figure 1: NYMEX Light Sweet Crude Oil Futures Average Daily Volume and Open Interest

LIQUIDITY DATA AND METHODOLOGY

The December contract (CLZ) is often the most-traded monthly contract with a large number of open interest holders on the WTI futures curve. Energy firms, commodities trading houses and financial institutions usually use this contract for hedging activities for their natural long or short positions. Therefore, liquidity changes for the December contract is a direct indicator of fluctuations in liquidity in the mid-to-long term maturities on the futures curve. It directly reflects the cost of trading for mid-to-long term futures contracts particularly for traders that are sensitive to potential market impact due to large orders.

In this white paper, the concentration of our analysis focuses on the order book data within the month of December, which eliminates the outliers in trading activities by utilizing data for the entire month. For a comprehensive view of the market depth and width, we examine the bid/ask spreads and order quantities in level 1 and level 2 of the order book for the specified periods for December contracts. Since the liquidity in near term contracts is always extremely liquid, we focus on the December contracts 2 years and 3 years forward.

For example, for trading period of December in 2016, we examine level 1 and 2 of the order books for December 2018 and December 2019 contracts. As illustrated below in Figure 2, open interest for December contracts is usually much larger (size of circle on the Figure 2) than other similar maturity contracts.

Figure 2: WTI Open Interest

LIQUIDITY ASSESSMENT: INCREASING LIQUIDITY MATCHING GROWING GLOBAL IMPACT

In the trading periods of December from 2013 to 2016, Bid/Ask spread and quantity both show increasing liquidity from 2013 to 2016. The order quantity at book level 1 & 2 increases year over year as shown in Table 1. In 2016, the quantity significantly increases. The spread widens in 2014 slightly but quickly tightens in 2015 and further so in 2016, signaling increasing liquidity in Table 2. From 2013 to 2016, order spread and quantity shows consistent annualized improvement in liquidity across the order book.

The sharp decline of crude oil prices from a $107 to a $30 level starting from June 2014 to the end of 2015 does have a certain impact on WTI liquidity. It is mostly reflected in the bid/ask spread in the longer maturity contracts as shown in Figure 3.c and Figure 3.d. In book level 1 and 2, 36 months forward December contracts show a slight widening of spreads in 2014 and 2015. Book depth has not been impacted as much showing increasing quantities in the number of contracts overall since 2013. This is in line with our observations in growing open interest and volume as shown in Figure 1.

Table 1: Bid/Ask Time-Weighted Average Quantity

Order book 2013 B/A Qty 2014 B/A Qty 2015 B/A Qty 2016 B/A Qty Annualized Change
24 months forward, Level 1 2.25 2.33 3.26 6.51 42.5%
24 months forward, Level 2 2.38 2.56 4.29 12.47 73.6%
36 months forward, Level 1 1.72 2.15 2.06 3.95 32.0%
36 months forward, Level 2 1.64 2.33 1.96 6.21 55.7%

 

Table 2: Bid/Ask Time-Weighted Average Spread

Order book 2013 Spread 2014 Spread 2015 Spread 2016 Spread Annualized Change
24 months forward, Level 1 $56.80 $60.70 $46.51 $29.31 -19.8%
24 months forward, Level 2 $86.28 $89.76 $71.33 $49.84 -16.7%
36 months forward, Level 1 $91.35 $134.48 $118.20 $50.33 -18.0%
36 months forward, Level 2 $130.83 $211.09 $195.26 $76.91 -16.2%

A more detailed look at each book level and tenor:

Figure 3.a: WTI Liquidity, Dec Trading for 24 Months Forward Dec Contract: Book Level 1

  • Book depth increases year over year from 2.3 (# of contracts) in 2013 to 6.5 (# of contracts) 2016.
  • Spread widens slightly in 2014, but quickly tightens from 2015 to 2016, showing increasing liquidity.

Figure 3.b: WTI Liquidity, Dec Trading for 24 Months Forward Dec Contract: Book Level 2

  • Book depth increases year over year from 1.9 (# of contracts) in 2013 to 12 (# of contracts) 2016.
  • Spread widens slightly in 2014, but quickly tightens from 2015 to 2016, showing increasing liquidity.

Figure 3.c: WTI Liquidity, Dec Trading for 36 Months Forward Dec Contract: Book Level 1

  • Book depth increases from 2014 but decreases slight in 2015, then increase sharply in 2016, showing increasing liquidity overall.
  • Spread widens slights in 2014, but quickly tightens from 2015 to 2016, showing increasing liquidity.

Figure 3.d: WTI Liquidity, Dec Trading for 36 Months Forward Dec Contract: Book Level 2

  • Book depth increases slightly from 2013 to 2015, then increases sharply in 2016, showing increasing liquidity.
  • Spread tightens year over year, showing liquidity increases.

CONCLUSION

In 2016, with global crude oil price recovery, the spread overall tightens up significantly across all maturities and book levels, showing robust liquidity increase not only in the near term contracts but also further along the futures curve. In 2017, the year-to-date WTI open interest and volume continue to break historic levels, indicating further liquidity growth in the forward contracts. Managing risk in the long term for our clients has never been easier and more cost effective.

References

WTI and the Changing Global Dynamics of the International Crude Oil Trade https://www.cmegroup.com/education/files/wti-and-the-changing-dynamics-of-global-crude-oil.pdf

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