Why oil prices predicted by financial markets are missing the mark

We’ve hit the two month mark of this historic energy supply disruption, spurred by President Donald Trump’s war with Iran and the subsequent closure of the Strait of Hormuz. Every day, as countries make their way through inventories and less oil is being produced and delivered, the competition gets steeper for new barrels.

That competition is showing up in the physical market for oil — the very high price you pay to get a barrel delivered today. But that price is different from what financial markets tell us the price of oil should be or will be.

Let’s say a distributor is trying to buy a million barrels of crude oil. It had a contract from a producer in the Middle East, but that oil is tied up in the Strait of Hormuz. So it needs oil, now, on the spot market. And for a lot more money.

“The physical market is skyrocketing. We've seen delivery for physical Brent crude going, you know, like $144,” said Joe DeLaura, senior energy strategist at Rabobank.

That’s well above the “on paper” prices being set by Wall Street types.

“It's a divergence of what people think versus reality,” DeLaura said.

There’s a tension between what financial markets think is going to happen with the war versus what it’s like to actually get oil in the physical market today.

“The financial markets are essentially saying over a period of time, the expectation is, peace is going to break out and that prices will come down. So I think that's what the market's telling us. My view is they don't reflect the tightness of the current physical market,” said Dan Pickering, chief investment officer of Pickering Energy Partners.

He expects that futures prices will have to come up to reflect that reality.

“The Strait of Hormuz is not opening. Our inventories continue to draw down literally every single day. And I think where we're headed is that physical tightness in one part of the world is going to meld into physical tightness across the world,” he said.

The reality of the physical market is already starting to hit, said Tom Seng, a professor of energy finance at Texas Christian University.

Just look at oil price spikes this week: “To me, it's almost as if the market woke up and said, ‘Oh, look, we got to stop being optimistic,’” Seng said.

But are financial markets pessimistic enough?

While there’s always a chance this war could end tomorrow, Seng thinks that with summer travel season coming up, prices should probably be even higher than markets are expecting.