Sign in to follow this  
Followers 0

"Explaining The Disconnect Between Physical And Paper Oil Markets" by Alex Kimani at

Recommended Posts

  • Bears and bulls are butting heads over the current state of the oil market.
  • There’s a growing disconnect between the physical market for crude and oil futures.
  • The ongoing disconnect between physical crude and futures markets can mainly be pinned on worsening fears of a serious economic slowdown that might curtail oil demand

Explaining The Disconnect Between Physical And Paper Oil Markets

By Alex Kimani - Jul 10, 2022, 6:00 PM CDT

  • Bears and bulls are butting heads over the current state of the oil market.
  • There’s a growing disconnect between the physical market for crude and oil futures.
  • The ongoing disconnect between physical crude and futures markets can mainly be pinned on worsening fears of a serious economic slowdown that might curtail oil demand.

A couple of days ago, Saudi Arabia shocked oil punters after it hiked oil prices for its biggest market, Asia, in the middle of one of the biggest oil crashes this year. State producer Saudi Aramco hiked its key Arab Light crude grade for Asian customers by $2.80 a barrel from July's level to a premium of $9.30 a barrel over the regional Oman/Dubai quotes, bringing it just shy of the record $9.35 a barrel premium seen in May.

Aramco claimed that it has continued to see robust demand for crude from customers in Asia--the country's biggest market--as well as extremely strong refining margins.

The increase in the country's official selling price (OSP) came just hours before the futures market went into a tailspin, with Brent and WTI both crashing nearly 10% on Tuesday. Indeed, benchmark Brent futures have slumped 11.3% just two days after the price hike, ostensibly on weak demand and recession fears.

On a certain level, Saudi Arabia's 'mad' decision to hike prices in this environment appears to make sense.

After all, refining margins have gone amok, with the profit from making a barrel of gasoil at a typical Singapore refinery hitting an all-time high of $68.69 on June 24. Although the margin has since retreated to $41.80 a barrel at the close on Wednesday, it's still almost 4x higher than the $11.83 at the end of last year, and a staggering 550% above the profit margin at the same time in 2021.

But the fact that the physical market for crude (bullish) doesn't seem to match the futures market (bearish) suggests there is a serious disconnect between the two.

Physical vs. Paper Market Disconnect

At this juncture, it's important to make the distinction between the physical market for crude and the crude futures market.

Physical (also known as cash) market prices are determined by the supply and demand for physical crude. Here traders buy oil from the producer and sell it to the refiner for immediate delivery. Physical buyers and sellers have a direct pulse on the market and may feel immediately when it is well supplied, or not.

Futures prices, on the other hand, are determined by the supply and demand for crude futures positions. Futures markets provide traders with a means to bet on crude prices at certain points in the future, and also allows physical market participants to hedge their position and, therefore, minimize risk.

The ongoing disconnect between physical crude and futures markets can mainly be pinned on worsening fears of a serious economic slowdown that might curtail oil demand.

"A growing number of analysts are expecting that many of the world's leading economies will suffer negative growth in the next few months, and this will drag the U.S. into a recession," Fawad Razaqzada, market analyst at City Index, has told Bloomberg.

Related: The One Commodity That Won’t Stop Soaring

Months of dwindling liquidity, alongside heavy technical selling as well as hedging activity by oil producers, have all contributed to the oil futures selloff. However, the biggest driver has been concern about a possible recession and an overly hawkish Fed, which have served to undermine the idea of oil prices being a means of hedging against inflation. 

"Recession fears likely pushed some investors out of the oil trade as an inflation hedge," Giovanni Staunovo, analyst at UBS Group AG, has told Bloomberg.

Last month, Federal Reserve officials determined to maintain an aggressive interest rate hike regime in a bid to cool down inflation and prevent it from becoming entrenched, even if that means slowing down the U.S. economy. According to minutes of the Federal Open Market Committee's June 14-15 policy meeting, the central bank plans to increase rates by either 50 or 75 basis points at its next meeting slated for July 26-27, hot on the heels of a 75-basis points raise in June--the biggest in nearly three decades. Indeed, it's June's massive hike that triggered the ongoing oil price selloff, meaning the oil bulls might not get a much-needed reprieve any time soon.

And now, the million-dollar question: will other oil producers take their cues from Saudi Arabia?

Saudi Aramco does not disclose the pricing formula that it employs to set its OSPs; however, experts think it's a fairly technical process that takes into account refining margins, the relative price between Oman/Dubai and Brent, and the actual volumes being sought by refining customers.

The big problem with using a technical process to determine your OSP as the Saudis do is that the price cannot quickly adapt to the highly unusual circumstances in the current global oil market.

Lower Brent prices will encourage refiners in Asia that can easily switch crude grades to buy more oil from suppliers such as West African producers, including Angola and Nigeria, that price against the global benchmark. Further, Asian refiners that have no qualms about buying highly discounted Russian Urals will also jump ship, thus leaving Saudi crude and the Middle East grades that price against it less desirable.

By Alex Kimani for

More Top Reads From

Latest articles from Alex Kimani

Share this post

Link to post
Share on other sites

Don't miss this article by Alex Kimani...

Big Oil’s Boardroom Battles Subside As Climate Activism Loses Steam

By Alex Kimani - Jul 04, 2022, 5:00 PM CDT

  • Big Oil’s boardroom battles over climate activism seem to be on the decline.
  • Investor sentiment is back in the favor of oil and gas production as prices continue to climb higher.
  • Russia's invasion of Ukraine has also forced investors and companies to think more about energy security.

Last year proved to be a watershed moment for oil and gas companies in the global transition to clean energy, with Big Oil facing a series of boardroom and courtroom battles against hardline climate activists.

The world's largest publicly-traded oil company, Exxon Mobil (NYSE:XOM), lost three board seats to Engine No. 1, an activist hedge fund, in a stunning proxy campaign. Engine No. 1 demanded that Exxon needs to cut fossil fuel production for the company to position itself for long-term success. "What we're saying is, plan for a world where maybe the world doesn't need your barrels," Engine No.1 leader Charlie Penner told the Financial Times. Engine No. 1 enjoyed a stunning victory thanks to support from BlackRock Inc. (NYSE:BLK), Vanguard, and State Street who all voted against Exxon's leadership.

Next was its close peer, Chevron Corp.(NYSE:CVX), with no less than 61% of Chevron shareholders voting to further cut emissions at the company's annual investor meeting a week ago and rebuffing the company's board which had urged shareholders to reject it. 

Finally, a Dutch court ordered Royal Dutch Shell (LON:SHEL) to cut its greenhouse gas emissions harder and faster than it had previously planned. Never mind the fact that Shell already had pledged to cut GHG emissions by 20% by 2030 and to net-zero by 2050. The court in The Hague determined that wasn't good enough and demanded a 45% cut by 2030 compared to 2019 levels. The past two years have been especially challenging for Shell shareholders after the company announced a major dividend cut with the quarterly dividend falling to 16 cents from 47 cents, the first dividend cut since WW11. Meanwhile, the company's debt had ballooned massively from $1bn in 2005 to $73bn in 2020.

Luckily for these oil and gas supermajors, investor sentiment has once again shifted in their favor.

Encouraged by last year's victories, including rules that made it easier to put public policy-related questions on proxy ballots,  an analysis by the Conference Board of data supplied by Esgauge has revealed that climate activists have filed 389 environmental and social proposals with member companies of the Russell 3000 index so far this year. 

However, the share of support for environmental proposals has dropped from 37% in 2021 to 33% this year, reflecting a growing aversion by asset managers to tying managers' hands when it comes to climate-related issues. Russia's invasion of Ukraine has also forced investors and companies to think more about energy security.

Extreme demands

Ironically, it's none other than the world's largest asset manager, BlackRock Inc., that set the tone earlier this year when it warned that it would be voting against shareholder resolutions on climate that it considered to be too extreme or prescriptive. 

Over the past few years, BlackRock has been at the forefront of encouraging oil and gas divestments, with CEO Larry Fink calling for corporate climate disclosures while also proclaiming that companies must have a purpose beyond profit.

Back in 2019, BlackRock declared its intention to increase its ESG (Environmental, Social and Governance) investments more than tenfold from $90 billion to a trillion dollars in the space of a decade. 

With $9.6 trillion of investments under its watch, BlackRock can certainly throw its weight around.

Indeed, in 2020, the firm voted against 69 companies and 64 company directors for climate-related reasons while placing another 191 companies on watch.

Other money managers are following suit:

"It's the board's role to oversee and direct corporate strategy. As long-term shareholders, we need to be as pragmatic and consistent as possible," Ben Colton, head of stewardship at State Street Global Advisors, has told the Financial Times.

According to the Conference Board analysis, proposals asking management to report on several environment-related options have been receiving significantly higher backing than those that have sought to restrict management behavior. The report reveals that seven resolutions asking for reports on plastic pollution garnered an average of 45% support; on the contrary, the ten demands that banks and insurers stop financing new fossil fuel development received average support of just 10%.

Last month, Exxon recorded a major victory after its shareholders supported the company's energy transition strategy at the annual general meeting. Only 28% of the participants backed a resolution filed by the Follow This activist group urging faster action to battle climate change; a proposal calling for a report on low carbon business planning received just 10.5% support, while a report on plastic production garnered a 37% favorable vote.

Following in the footsteps of its larger peer, in June, Chevron shareholders voted against a resolution asking the company to adopt greenhouse gas emissions reduction targets, indicating support for the steps the company already has taken to address climate change.

Just 33% of shareholders voted in favor of the proposal, according to preliminary figures disclosed by the company, a sharp turnaround from last year when 61% of shareholders voted to support a similar proposal.

It appears that ESG and climate activism are now taking a backseat amid the global energy crisis, meaning the legacy businesses of fossil fuel companies remain safe--at least for now.

By Alex Kimani for

More Top Reads From

Share this post

Link to post
Share on other sites

Join the conversation

You can post now and register later. If you have an account, sign in now to post with your account.

You are posting as a guest. If you have an account, please sign in.
Reply to this topic...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Sign in to follow this  
Followers 0