Crude prices mask deeper oil market stress

Key Points:

• Benchmark crude prices understate the severity of disruption, with stress concentrated in refined products and prompt physical markets
• Diesel and jet fuel margins signal acute tightness as both crude and product flows from the Middle East remain constrained.
• Asian-linked crude benchmarks and front-month contracts trade at a premium amid aggressive bidding for immediate supply.
• A sharp drawdown in global oil-on-water is removing a key buffer that initially dampened crude price reactions.

At first glance, the oil market reaction to the Iran war appears relatively contained, with price action in Atlantic Basin crude benchmarks suggesting some degree of normalisation following the initial geopolitical shock. Brent crude has eased back toward USD 100 a barrel, while WTI trades below USD 94 with the discount between the two benchmarks widening to near four-year high.

However, this surface stability masks a market that remains under significant strain. The key point is not where crude prices are trading, but how and where the stress is being expressed. Increasingly, the answer lies beyond flat price crude—in refined products, regional dislocations, and the front end of the futures curve.

The Strait of Hormuz remains effectively closed, with only limited vessel traffic navigating the chokepoint under persistent security threats. While pipeline flows from Saudi Arabia and the UAE, along with resumed exports via Turkey from northern Iraq, have provided partial relief, these alternatives cannot fully replace the flexibility and scale of seaborne flows through the Gulf.

At the same time, the nature of the disruption has evolved. The Persian Gulf is no longer just a crude export hub. Over the past decade, it has developed into a major refining centre, supplying diesel, jet fuel and other refined products to global markets. As a result, current disruptions are simultaneously constraining both crude availability and refined product exports—particularly those critical to Europe and Asia.

This shift helps explain why refinery margins continue to signal acute tightness, especially in middle distillates. Diesel and jet fuel markets remain under significant pressure as refiners struggle to secure suitable feedstock and maintain output. In effect, the bottleneck has moved further down the value chain.

A further explanation for the relatively muted response in crude prices lies in the presence—and recent erosion—of floating storage. Global oil-on-water reached a record 1.37 billion barrels last December, surpassing levels seen during the 2020 pandemic when demand briefly collapsed. This elevated inventory acted as a temporary buffer, allowing supply disruptions to be absorbed without an immediate and disorderly spike in crude prices.

That buffer is now diminishing. In recent weeks, global oil-on-water has fallen sharply and is already moving back toward its historical range. As floating storage declines, the market is becoming increasingly exposed to real-time supply constraints. This transition is likely to shift pricing power toward prompt barrels and increase sensitivity to further disruptions.

This dynamic is already visible in the structure of the futures curve. Crude markets are exhibiting pronounced backwardation, with front-month contracts trading at a significant premium to deferred deliveries. Such a structure reflects immediate scarcity, with market participants willing to pay up for near-term supply rather than rely on future availability.

Regional pricing reinforces this picture. Benchmarks crude contracts in Dubai and Oman trade near USD 160 per barrel as refiners bid aggressively for prompt cargoes amid reduced Middle East supply. In contrast, markets less directly exposed to immediate physical shortages have shown a more subdued response, contributing to a growing divergence across crude benchmarks.

In this environment, proximity and timing have become critical pricing factors. Access to prompt supply—particularly barrels that can reach Asia quickly—commands a premium, while barrels further removed from the physical tightness trade at a discount. This reflects a market that is increasingly fragmented, rather than one that is returning to balance.

The result is a shift in how stress is transmitted through the oil market. Instead of being fully reflected in outright crude prices, it is now visible in elevated refinery margins, stronger product prices, regional dislocations, and the steepness of the forward curve.

Brent near USD 100 may appear manageable in isolation, but when viewed alongside record backwardation, tightening product markets, and falling floating storage, it becomes clear that underlying conditions remain far from balanced, with the risk of a prolonged war eventually lifting prices, in a worst-case scenario to levels that trigger demand destruction, just like we saw in Europe during the 2022-23 gas price spike.

In short, the oil market is not signalling normalisation. It is signalling a redistribution of stress—away from flat price crude and into the parts of the system most directly exposed to disruption.