The oil market is in ‘backwardation’ — what it means for energy prices

Oil prices have been volatile since the US-Iran war began about four weeks ago.

But analysts say the market has now entered a “downturn” that indicates a risk premium has been added to energy prices, even as traders expect a quick resolution to the dispute.

Oil prices fell sharply on Wednesday as investors reacted to reports that the White House had sent Iran a 15-point peace plan aimed at ending the conflict.

But mixed messages from Washington and Tehran regarding the status of peace negotiations, ongoing missile attacks in the Middle East and the ongoing traffic buildup in the Strait of Hormuz have kept prices high.

Front-month global benchmark Brent crude oil futures are still hovering around $99 per barrel; This is almost 36% above the level before the US and Israel first attacked Iran on February 28.

Meanwhile, US West Texas Intermediate futures for April delivery were last traded around $87.76; this was approximately 30% higher than at the start of the war.

But prices along the futures curve tell another story. Oil market backwardation: A situation in which futures contracts involving immediate or near-term deliveries are sold at a higher price than those for later deliveries.

“This pullback (lower prices in the future compared to today) suggests that the market thinks the current rise in oil prices is temporary,” Toni Meadows, chief investment officer at BRI Wealth Management, told CNBC on a video call.

“So it’s not something that will stay with us, it’s an event. Otherwise, you’ll pay more for future deliveries due to supply shortages. So yes, there is a problem at the moment due to conflicts, but the expectation is that there will be some resolution.”

Meadows said it was difficult to decide whether that was a reasonable outcome.

“We don’t know the full story of what happened,” he told CNBC. “Trump is definitely looking for a way out, he’s been doing that all week. But the Iranians said they weren’t talking.” [to the U.S.] — where does the truth lie? “I think the markets are playing cautiously right now.”

He noted that European gas prices have not risen as much as they did after Russia’s full-scale invasion of Ukraine in 2022, but said there is still a traffic backlog in the Strait of Hormuz and markets may not price in all the potential ways the situation could play out.

“Right now, if there is some kind of solution, it might just be a subdued price increase, but it’s hard to see what that path might be,” he said.

“If it’s short-lived, if they can find a way out, and the capacity in the region hasn’t been destroyed, that’s one thing, [but] It’s a very fragile mixture. A missile changes the equation. This isn’t just about negotiations. “Once LNG facilities are destroyed, it takes years to bring them back online.”

He added that it would be very difficult for the US to completely eliminate Iran’s nuclear ambitions by bombing the country.

“We still have 400 kilograms of uranium enriched to 60%; it doesn’t take much to get that to 90%. The Iranians have the technology and can force it underground,” Meadows said. “Given the range of potential outcomes, I would say markets are relatively calm.”

Katy Stoves, chief investment officer at Mattioli Woods, told CNBC that the pullback behavior occurring in the oil market is “pretty normal in a shock like this.”

“I think people are expecting some kind of reduction in hostilities, and this signals that,” he said. “But on the other hand, it could equally potentially be a little more worrying. [forecasting] “There is a decrease in demand.”

Gas and airfares have already increased in the United States in the almost four weeks since the United States and Israel launched their first attacks.

“Even if we get to a solution, I think a lot of energy infrastructure has been destroyed in the process, and even if we get some kind of ceasefire… it’s going to take time to repair these facilities, to get these facilities back up and running, and I’m not entirely sure the market is probably pricing that in,” Stoves said.

Indrani De, head of global investment research at FTSE Russell, told CNBC that although market expectations are for lower prices over the long term, volatility and risk are still priced in.

“If you look at the oil futures curve, it depends on where expectations are going to be.” [prices are] It will be very variable. “It continues to move, but the shape of the curve is pretty consistent,” he said.

“It’s in a deep downturn with a sharp drop after about four months, and then about 10 months later, around the end of the year, it’s back to pretty much normal – in the sense of normal… about $10 higher than when this conflict started.”

Brent futures for December delivery are currently priced around $79.70. This represents a 17 percent decrease from the previous month, but a 10 percent increase from pre-Iran war prices.

“Therefore, the heavy downside suggests that even the worst-hit market is pricing in early resolution [to the conflict]”But if you look at where the level will end up 10 months from now, you’ll see Brent ending at prices about $10 to $12 per barrel higher than before the crisis. So I would say that’s kind of a risk premium built into the market now,” De told CNBC.