- Oil (and stock markets) try to shrug off latest military engagement between Iran and America
- Brent crude trades just below $100 a barrel
- Oil futures are still in ‘backwardation’ all the same to suggest near-term supply stresses remain
- Price increases all along the futures curve would speak of increased concern over long-term global supply
“Despite the latest military skirmishes between America and Iran, the price of Brent crude stands just below $100 a barrel, to suggest that financial markets’ are keeping faith in their preferred and anticipated outcome of a peaceful resolution, a reopening of the Strait of Hormuz and a normalisation in the supply and price of oil,” says AJ Bell investment director Russ Mould.
“But investors need to think about how oil is priced when they consider whether, or for how long, the cost of crude could influence global inflation and growth, and, in turn, central bank monetary policy, corporate earnings and consumer confidence.
Source: LSEG Refinitiv data
“The prevailing price quote of $99 a barrel for Brent crude refers to futures prices for delivery in July. It is the price of ‘paper’ oil, used by producers, buyers, and traders to manage and hedge their exposures as much as it is to arrange and take shipment.
“Anyone wanting physical delivery today will have to pay a premium.
“Moreover, at the time of writing, Brent crude for delivery in August trades at $96.45, for December at $77.58 and at $75.55 for one year’s time. That May 2027 delivery price is not too far away from the $70-a-barrel mark at which Brent crude traded before the US launched its first strikes on Iran on the last day of February.
Source: LSEG Refinitiv data, ICE. As of 26 May, at 10:00
“This downward sloping price curve from physical oil to paper futures is known as ‘backwardation.’ This is normally a sign that near-term supply remains tight relative to demand.
“The opposite, when later futures prices are higher than near-term ones, is known as ‘contango.’ An upward-sloping futures curve usually signifies a near-term glut, as oil trades price the cost of storage into future delivery.
“Given the ongoing blockades in the Strait of Hormuz, no-one will be surprised to see the oil price curve in backwardation.
“In addition, the downward sloping price curve may reflect confidence that supply will return to the market once Washington and Tehran reach a peace settlement soon, a scenario which equity markets are discounting too, judging by how many major indices trade at or near to all-time highs.
“The easing of sanctions against Russia, or at least Russian-sourced products, the UAE’s break away from OPEC+ and the use of strategic reserves to boost near-term supply are also convincing markets that the oil price will not stay higher for longer on a sustained basis. America’s ongoing production boom is also a source of reassurance, thanks to shale, and a welcome contrast to the oil price shocks of the 1970s, when America was an importer and not an exporter.
Source: US Energy Information Administration
“Crude has barely threatened the high reached in 2022 after Russia’s attack on Ukraine, let along the all-time peak of $147 seen in 2008.
“But even a peace settlement may not permit the oil price to retreat to its pre-war mark of $70 a barrel too quickly.
“Tankers still must return to the Gulf, load up, ship and unload oil, while producing nations may have to repair damage to their facilities and refineries. In addition, consumers of oil may wish to replace the stockpiles that they are currently running down to ensure that they are prepared for any future oil price shocks.
“America’s Strategic Petroleum Reserve, at 374 million barrels, stands well below maximum capacity of 714 million barrels while total stockpiles, at 820 million barrels, are not much above levels last seen in December 1986, when West Texas Intermediate crude traded at just $17 a barrel and such matters seemed less important.
Source: US Energy Information Administration
“Investors must therefore watch not just how the one-month futures oil price develops but the entire futures curve.
“If the oil market remains in backwardation, and later-dated futures start to rise just as sharply, or faster, than the near-dated paper oil price then that could be sign of stress in the market and ongoing tight supply. Equally, the opposite may apply if the market moves into contango, to imply supplies are plentiful once more.
“This matters because equity markets are still pricing in a relatively speedy resolution to the stand-off between Washington and Tehran and a rapid resumption of oil supply, with all of the potential benefits that could bring, in the form of lower oil prices, cooler inflation, lower input costs for companies, lower bills for consumers and lower interest rates from central banks.
“Rising prices across the futures curve could be a sign that stock markets are too optimistic, while falling ones for near-term delivery and rising ones for oil supply in six to twelve months’ time would support the bullish thesis and the rally in share prices from the March lows.”
