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Oil Futures - Papering over the cracks
On April 30th, the June Brent contract expired (βrolledβ) around $114/bbl while the July contract, which immediately became the headline benchmark, traded closer to $108/bbl. Within days, deferred Brent pricing moved lower still, toward the high-$90s. Casual observers saw βoil fallingβ. The physical market was signalling something rather different.
The June-July backwardation had already widened to roughly $5-10/bbl depending on the point observed during expiry week (much lower than the extremes seen a few weeks earlier1, but way above βnormalβ). This is an extraordinary premium for immediate barrels in a market supposedly expecting normalization only weeks later. Reports of prompt physical cargoes trading well above benchmark futures, in some cases north of $120/bbl and occasionally far higher, continued circulating through trading desks and shipping markets.
So the market is saying tight-ish supply now (although even $150/bbl oil would not be an inflation adjusted ATH - that would be more like $220/bbl), and what looks to me like a worrying degree of complacency about near months, and complete capitulation further out. Maybe it is all a big nothing burger?
The Something Burger
A decade or so (more!) ago, rumours of disruption would have moved the curve up, all the way out. higher prices now and higher prices later. Yes backwardation, but not steep. Today we have actual disruption - on a scale that has never been tested.
So what is different now?
The answer would appear to be a complex set of factors. There is the physical market and the much larger financial market - the fluffy bun of processed bread that is hiding the something burger.
Physical recovery operates on logistical rather than financial timescales. Even assuming full reopening tomorrow, the system does not magically reset. Tankers already displaced must complete round trips. Floating storage has been consumed. Strategic reserves that were drawn down require replenishment. Refineries have altered crude slates and product balances. Oil on water has effectively been borrowed from the future. Add in countries facing supply concerns may opt for new or increased existing strategic reserves in the near future.
Today the market faces actual sustained disruption, visible inventory depletion and mounting logistical strain, yet deferred Brent remains around $97/bbl.
The paper market appears to be pricing normalization faster than the physical system can plausibly deliver it.
Part of the explanation is structural. Futures markets are dominated by financial actors rather than physical buyers and sellers. The Brent curve is not a forecast; it is a probability-weighted clearing mechanism. The market may implicitly be pricing something like a 30% probability of prolonged $140+ oil against a larger probability of recession, political intervention, strategic reserve releases and eventual reopening.
Something like:
30% chance of $150 oil,
50% chance of rapid normalization,
20% chance of recessionary collapse.
The shale era also conditioned markets to believe that high prices self-correct quickly. Mean reversion has become deeply embedded in commodity trading psychology. High prices are assumed to produce rapid supply response and demand destruction.
But neither mechanism appears especially convincing at current price levels. Inflation-adjusted oil prices around $97-120/bbl are elevated but not historically extreme. More importantly, suppressed deferred pricing discourages the very upstream investment needed to restore future supply elasticity. Shale players are explicitly looking at shareholder returns not increased short-cycle drilling. Conventional oil does not sanction long-cycle drilling programmes based on temporary spot panic while the forward strip sits at the economics required for confidence.
In addition, for those who believe(d) that OPEC (as was) had lots of spare capacity - it is worth noting that this is almost on the wrong side of the Strait of Hormuz, so not exactly the cavalry waiting to charge over the hill.
At the same time, demand destruction is already appearing in some sectors, particularly aviation. That is notable because the destruction may not be price-led in the classic economic sense. Physical scarcity, product dislocation and logistical friction are beginning to constrain activity directly. That is a far more serious signal than consumers simply reacting to expensive gasoline.
Hot tip - if you want to fly - go via the UAE - great airlines and massive glut of (cheap) jet-fuel needing to be used.
Papering over the cracks
It is well known that the financial oil market is vastly larger and more liquid than the physical market it supposedly represents. In theory, that should improve price discovery. In practice, it may be disguising the underlying stresses.
Modern oil trading remains psychologically anchored to the shale-era, when supply shocks repeatedly proved temporary and high prices quickly self-corrected through short-cycle drilling bringing on more supply. Betting on prolonged scarcity has often been punished across recent US administrations - whatever the ideological grandstanding. Mean reversion became embedded into market psychology.
Most futures participants are also not physical oil actors. Pension funds, macro traders and systematic strategies increasingly dominate turnover. Many are trading inflation expectations, recession risk or positioning rather than tanker cycles, refinery balances or depleted inventories in the Gulf. The market therefore prices probability-weighted macro outcomes more than it prices molecules.
As a macro viewer, the paper market may believe economic weakness will reduce demand almost as quickly as disruption reduces supply. If aviation slows, petrochemical margins compress and industrial activity weakens, deferred demand falls. In that framework, subdued forward prices reflect expected recession as much as expected normalization (and as noted above - the βpriceβ is a statistical outcome.
But reopening is not the same thing as normalization. Even if transit resumes tomorrow, inventories remain depleted, strategic reserves require rebuilding, tankers are displaced and refinery systems remain unbalanced. Physical systems recover on logistical timescales, not financial ones.
Liquidity itself may also be masking the strain. Benchmark futures remain highly tradable even as the underlying physical market fragments into opaque bilateral deals and regional scarcity pricing. The visible curve can therefore understate the true marginal cost of physical barrels.
The result is a widening divergence between the physical and financial views of the market. Physical markets are pricing scarcity and logistical stress. Financial markets continue pricing eventual normalization plus demand destruction.
My oil-guru echo chamber is screaming βcrisisβ, the market shrugs and screams βtechβ.
Rolling in the deep
The likely outcome is a repeated rediscovery of scarcity. As each contract approaches expiry, prices converge upward toward immediate physical conditions. Then the market rolls forward again and resumes pricing reassurance. The saw-tooth behaviour seen during the April Brent roll may prove to be a structural feature of this market rather than a temporary anomaly.
The curve does not fully reprice upward. It repeatedly rediscovers reality one contract roll at a time.