Oil Prices Ignore Physical Market Reality Amid Iran Conflict

Oil prices have been surprisingly stable despite severe disruptions in Middle Eastern supply. The reason is sheer optimism and a bet on market adaptability. However, this optimism may be misplaced as warning signs are flashing in physical markets.

Futures prices have not reflected the severity of the disruption, which is comparable to 2022 when Russia's incursion into eastern Ukraine prompted an actual surge in oil prices. At the time, Western sanctions were a major concern, but Russian oil continued flowing abroad. Similarly, Saudi Arabia and the UAE redirected oil flows from the East to the West, while Iraq is considering doing the same.

Despite broken ceasefire deals, inflammatory rhetoric, and failed negotiations, the market remains hopeful for a peace deal. However, analysts are warning that if the war extends beyond June, global crude inventories will be depleted, and shortages will emerge in fuels. Crack spreads are at all-time highs, reflecting an increasingly tighter market.

Global oil inventories are being drawn down considerably, with the U.S. Strategic Petroleum Reserve nearing a critical level. Gasoline, diesel, and jet fuel supply is tightening due to demand outpacing supply. Despite these warning signs, optimism persists as Brent and WTI prices remain below $90 per barrel.