Oil Futures Market Pricing Trends Raise Concerns About Transparency

Oil Market Grapples with Massive Disruption in Strait of Hormuz

The global oil market is facing its biggest disruption since the Suez Crisis in 1956, with roughly 15 million barrels a day of oil supply, or 15% of global demand, bottled up in the Strait of Hormuz. This has resulted in a significant drawdown on global stockpiles, with an estimated 500 million barrels already drawn since the disruption began.

According to estimates by Goldman Sachs Group Inc., this number could hit a billion barrels by June, or even Memorial Day, if current trends continue. This would represent a massive deficit in the global oil system, even if a peace deal opens the Strait.

Brent crude oil futures have rebounded above $100 a barrel, but the market seems strangely sanguine given the scale of the disruption. Prices for 2027 are up 17% compared with 43% for front-month contracts, a disparity that Kaes Van’t Hof, chief executive of Diamondback Energy Inc., has described as "the back end of the curve lying to us."

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The disruption is equivalent to about 6% of global observed inventories, a decline that is already the sharpest two-month drop in OECD data going back to 1988. By June, global inventories could be down by 10-12%, a drop that would be far beyond the scope of prior declines.

The drawdown on inventories is the physical manifestation of a tight oil market, where supply isn't covering demand, and futures prices should rise accordingly. However, prices have sold off since their peak in early April, even as stocks have continued to fall with the Strait effectively closed.

Technical factors have also played a role in the market's response, argues Ilia Bouchouev, former head of derivatives trading at Koch Global Partners. Hedge funds, who initially entered the year without much exposure to oil, piled into the front end of the curve when hostilities broke out, exacerbating the surge in near-term futures prices.

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However, the volatility induced by the disruption forced many hedge funds to sell to manage risk or take profits, a "shock absorber" effect that may not last.

Even if conditions stay stable, the rapid drop in inventories will trigger another bout of buying, unless arrested. In the most optimistic scenario, where Hormuz opens immediately, it would still take months to clear the backlog of blocked tankers, local oil in storage, and shut-in wells.

US oil executives canvassed by the Federal Reserve Bank of Dallas in an interim survey released Thursday concur, with four-fifths not expecting traffic through the Strait to resume normal levels before August, and 40% thinking it will be November or later.

The bigger the vacuum becomes, the longer it will take to refill those inventories, and oil prices along the curve would need to rise accordingly to encourage excess production or destroy demand.