Iranian security personnel monitor the area of Phase 19 of the South Pars gas field in Assaroe on Iran’s Persian Gulf coast, August 23, 2016.
Morteza Nicobazul | Nur Photo | Getty Images
Oil prices have been volatile since the war between the United States and Iran began about four weeks ago.
But analysts say that even as traders hope for a quick resolution to the dispute, the market is now in a state of “backwardation” suggesting a risk premium is being built into energy prices.
Oil prices plunged as investors reacted to reports on Wednesday that the White House had sent Iran a 15-point peace plan aimed at ending the conflict.
However, mixed messages from Washington and Tehran on peace talks, ongoing missile attacks in the Middle East and continued traffic jams in the Strait of Hormuz ensured that prices remained elevated.
Last month’s global benchmark Brent crude oil futures remained hovering around $99 a barrel, nearly 36% higher than before the first U.S. and Israeli attacks on Iran on Feb. 28.
Meanwhile, U.S. West Texas Intermediate futures for April delivery last traded around $87.76, about 30% higher than before the war started.
But across the futures curve, prices tell a different story. The oil market is in backwardation. This is a phenomenon in which futures contracts with immediate or short-term delivery sell for a higher price than subsequent delivery.
“This backwardation, or lower prices in the future compared to now, indicates that the market believes the current increase in oil prices is temporary,” Toni Meadows, head of investments at BRI Wealth Management, told CNBC in a video call.
“So this is an event rather than something that stays with us. Otherwise, we’re going to be paying more for future deliveries because we’re in short supply. So, yes, we have a problem right now because of the fighting, but we’re hopeful that there will be some resolution.”
Meadows said it’s difficult to say whether this is a reasonable conclusion.
“We don’t know the full extent of what’s going on,” he told CNBC. “Trump is definitely looking for an exit, and has been doing so all week. But the Iranian side says they’re not talking[with the US]. Where’s the truth? I think the market is just reacting cautiously at this point.”
He said that although gas prices in Europe have not soared as high as they did after Russia’s full-scale invasion of Ukraine in 2022, there are still traffic jams in the Strait of Hormuz and markets may not have factored in all the ways the situation could develop.
“At this point, it is possible that some kind of solution could bring the price hikes under control, but it is difficult to see how that will happen,” he said.
“If it’s short-lived, if they can find an off-ramp and the production capacity in the area isn’t destroyed, that’s another thing, (but) it’s a very fragile combination. One missile changes the equation. It’s not just a matter of negotiation. Once an LNG plant is destroyed, it takes years to get it up and running.”
He added that it would also be very difficult for the US to completely weaken Iran’s nuclear ambitions by bombing it.
“We still have 400 kilograms of enriched uranium at 60% enrichment. It won’t take long to get that to 90%. The Iranians have the technology and could force it underground,” Meadows said. “Given the range of expected outcomes, I would say the market is relatively calm.”
Katie Stoves, an investment manager at Mattioli Woods, told CNBC that the backwardation behavior occurring in the oil market is “very normal in a shock like this.”
“I think people are expecting a reduction in hostilities, and it’s showing,” she said. “But by the same token, on the other hand, potentially a little more concerning, is the possibility of a (projected) decline in demand.”
Nearly four weeks after the United States and Israel launched their first attacks, U.S. gas and airfares have already skyrocketed.
“I think it’s very important to note that even if we get a solution, a lot of energy infrastructure has been destroyed during this time. Even if we get some kind of ceasefire… it’s going to take time to repair those facilities and get them back online, and I’m not entirely sure that the market is probably pricing in that,” Stoaves said.
risk premium
Indrani De, head of global investment research at FTSE Russell, told CNBC that while market expectations are for lower prices in the long term, volatility and risk are still priced in.
“If you look at the oil futures curve, which is an expectation of where[prices]are going, it’s very volatile. It keeps moving, but the shape of the curve is very consistent,” he said.
“Stock prices have been in a deep recession, plummeting after about four months and returning to near normal after about 10 months, around the end of the year. In a normal sense… they’re about $10 higher than they were before this dispute started.”
The price of December North Sea Brent futures is currently around $79.70. This is down 17% from last month’s price, but at a 10% premium to pre-Iran war prices.
“So the strong back positions indicate that even the worst-affected markets are pricing in an early resolution (of the dispute),” De told CNBC. “But if you look at where this level ends 10 months from now, we still end up with Brent oil prices about $10 to $12 per barrel higher than they were before the crisis. So you could say this is the kind of risk premium that’s built into the market right now.”
