Understanding Oil Prices Amid Global Conflict
Since February 28, the day the U.S. and Israel escalated their conflict with Iran, oil prices have been a hot topic worldwide. However, a key detail seems to be overlooked in the discussion on how oil prices are determined.
If you’re watching news channels or reading articles, you’re likely to see “Brent” and “Crude” mentioned together frequently.
Brent Crude is referenced by nearly every media outlet when analyzing the impact of the conflict on oil prices. It tracks the price of oil futures traded on the Intercontinental Exchange, serving as the global standard for the so-called “paper price” of oil.
So, what are oil futures exactly? According to a straightforward article on Investopedia, oil futures are contracts that enable investors to agree on a buying or selling price for oil on a future date, allowing them to hedge against price volatility.
To break it down, buyers and sellers decide on a price that will not be applicable today but rather at a later date. While nobody can precisely predict what oil prices will be in nine months, individuals in the oil futures market make educated guesses by locking in a future price.
For instance, if oil is currently priced at $30 per barrel, and someone believes it will rise to $45 by January, they might buy a contract for $35. If they’re right, they can buy oil at $35 and resell it for a profit. On the flip side, if prices don’t meet expectations, that contract becomes worthless.
To highlight the difference between paper prices and physical oil, a report from Reuters revealed that on April 7, European and Asian refineries had to pay as much as $150 per barrel for crude oil, whereas Brent Crude futures were quoted just over $109 per barrel on the same day.
The Wall Street Journal pointed out these discrepancies further on April 14, noting the price for Dated Brent—reflecting actual physical oil for delivery—rose to $132.74 per barrel, while the nearest Brent futures settled at $99.36. This discrepancy was described as unprecedented by Gary Ross, CEO of Black Gold Investors, establishing that such a significant oil market disruption is historically unusual.
Meanwhile, an April report from the International Energy Agency categorized the turmoil caused by the Iran War as potentially the worst oil supply shock recorded. It noted a growing disconnect between the paper pricing and physical pricing of oil, which has become increasingly problematic.
As countries dependent on oil scramble to find alternatives from a dwindling supply, physical crude oil prices have soared to unprecedented levels, nearing $150 per barrel, starkly contrasting with futures market prices. Furthermore, refined product prices have reached alarming highs, with middle distillates in Singapore exceeding $290 per barrel.
A tweet highlighted a specific instance where a barrel of oil recently sold in Sri Lanka for $286, far above futures prices, with some interpreting the conflict as a direct assault on Asian economies.
As people attempt to grasp the implications of this conflict on both the U.S. and global economies, it’s essential to note this critical distinction. The paper price represented by the Brent Crude benchmark is not reflective of the actual physical barrels, which are being traded at significantly higher prices.
