The oil futures market appears not to have caught up with the massive supply disruption from the Middle East yet—a supply shock that is now in its third month and lasting more than anyone expected in early March.
Brent and WTI crude futures this week are trading more than $30 per barrel higher compared to the levels on February 27, the day before the U.S. and Israel bombed Iran and prompted the Islamic Republic to close the Strait of Hormuz.
But the futures trade $20-$30 per barrel lower than the physical cargoes of some grades produced outside the Middle East, as Forties and Troll of northwest Europe and Angola’s Cabinda crude have recently hit $130 a barrel, while Sverdrup of Norway was bought in April at $150.
Detachment
The futures market seems too complacent compared to the major hit to supply, with no sign of a quick resolution and restoration of the trade flows at the Strait of Hormuz.
While the futures market responds to every signal out of Washington and Tehran about the ceasefire and the navigability of the Strait of Hormuz, including every late-night social media post by U.S. President Donald Trump, the physical market has already priced in the shock to supply. And it’s a sobering sight—over the past weeks, buyers have splurged $150 per barrel and more for some supply that’s not passing through the Strait of Hormuz.
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Yet, traders and speculators in the paper market are much more influenced by expectations, bets, and President Trump’s often contradictory messages and social media posts than by the reality of the huge physical disruption to supply.
For most of March and April, the buffer of stocks accumulated before the war – when the market expected an oversupply this year – helped cushion the impact on the oil futures prices. Traders were also betting on a reopening of the Strait of Hormuz by April 1, or by May 1.
Five days into May, not only is the Strait not open, but the tenuous ceasefire is cracking with renewed hostilities, the U.S. saying it would guide ships through Hormuz, and Iran threatening to attack any foreign forces attempting or entering the Strait.
More than two months of 10-15% of global oil flows choked off at the Strait of Hormuz has started to eat into global inventories at a very fast pace. No region can offset the losses, and every day the Strait of Hormuz remains closed pushes back the day on which Gulf producers can freely export their cargoes to the starved market.
Even if the Strait opened to unconditional free traffic today, the system will need months to restore flows, Gulf producers will need even more months to restart shut-in wells, and up to five years to repair the damage from attacks on upstream and downstream oil assets and LNG production and export infrastructure.
“The physical markets reflect the reality on the ground and the futures market reflects more perceptions and hopes,” Tamas Varga, an analyst at energy broker PVM Oil Associates, told Reuters last week.
“One might say that physical markets are the true reflection of what’s actually happening around the Strait of Hormuz.”
Underestimated Supply Shock
The futures market hasn’t fully priced in the enormous supply shock, which could mean a sharp spike into the peak summer season, Helima Croft, Head of Global Commodity Strategy and MENA Research at RBC Capital Markets, wrote in a note last week.
“For eight weeks, the White House successfully deployed an “over soon” message to cap front-month prices,” Croft said.
However, this optimism bias could backfire within weeks amid a continued closure of the Strait of Hormuz, the strategist noted.
“The physical market remains exceptionally tight with expectations for further upside into summer demand season as incremental demand converges with durable supply constraints.”
According to RBC’s Croft, “The ever-present optimism bias may be blinding market participants and policymakers to the iceberg looming under the surface as we close in on peak summer demand season.”
Throughout April, bets on early-May opening of the Strait of Hormuz collapsed, Brent Crude futures re-priced higher, and analysts and investment banks raised their year-end and rest-of-year forecasts to close to $100 per barrel.
Every week of delay beyond May 1 would theoretically add about 5 per barrel to the rest-of-year average Brent price as inventories draw at a pace of about 100 million barrels per week, analysts at SEB bank wrote in a report last week.
“A mid-May reopening implies rest-of-year Brent near $100/bl; June pushes us into uncomfortable territory; July risks a fullblown crisis where the world is forced to align consumption with availability,” commodities analysts Bjarne Schieldrop and Ole R. Hvalbye wrote.
The risks are firmly skewed to the upside, and another eight-plus weeks of further delays of reopening the Strait of Hormuz would push Brent Crude prices to $150-$200 per barrel, as the cumulative loss of supply would exceed 1.5 billion barrels, they reckon.
“The market is now living on borrowed time(!),” SEB bank’s analysts noted.
By Tsvetana Paraskova for Oilprice.com
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