Oil Markets Ahead: Pricing In More Risk

As the Strait of Hormuz continues to be a chokepoint for oil, our Global Head of Fixed Income Research Andrew Sheets and our Head of Commodity Research Martijn Rats discuss possible outcomes for the interconnected market.Read more insights from Morgan Stanley.----- Transcript -----Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley. Martijn Rats: I'm Martijn Rats, Head of Commodity Research at Morgan Stanley. Andrew Sheets: And today in the program: Oil flows through the Strait of Hormuz remain restricted. The implications for global energy markets and what may lie ahead.It's Wednesday, April 1st at 2pm in London. So, Martijn, it's great to sit down with you again. Three weeks ago, we were having this conversation; a conversation that was a little bit alarming about the scale of the disruption of the oil market with the closure of the Strait of Hormuz, and how that could have ripple effects through the global economy. Three weeks later, oil is still not flowing. What is happening? And what has maybe surprised you? Or been in line with expectations over the last couple of weeks? Martijn Rats: Yeah. Many things have been in line with expectations, in the sense that we're seeing the effects of the closure of the strait the earliest in regions that are physically the closest to the strait. So, we saw the first examples of physical shortages in, say, the west coast of India. Then we saw examples from the east coast of India From there on it's reverberated throughout Asia, where now governments have announced a whole host of. Effectively, energy demand, uh, management measures, uh, work from home, kids staying at home from school, um, cancellation of flights. There are quite many through, through Asia Also in Asia, we're seeing the type of prices that you would expect with this situation. Bunker fuel for shipping, somewhere between $150 to $200 a barrel. Jet fuel over $200 a barrel. Naphta going into Japan; naphta normally trades well below the headline price of Brent. Now $130 a barrel, that's more than double what it was in February. So, those things tell the story of this historic event. What has been surprising on the other end is how slow the reaction has been in many of the oil prices that we track the most. Like… Andrew Sheets: The numbers people will see on the news. You know, it's $100 a barrel maybe as we're talking. Martijn Rats: Yeah. It's strange to see jet fuel cargoes in Rotterdam more than $200 a barrel, but then the front month Brent future only trading at [$]100. That spread is historically wide and very surprising. But look, there are some reasons for it. The crude market had more buffers. There are a few other things. But how slow Brent futures have rallied? That has been somewhat surprising. Andrew Sheets: But you know, from those other prices you mentioned, those prices in Asia, those prices in Rotterdam that are maybe higher than the numbers that people might see on the news or on a financial website. Is it fair to say that in your mind that's sending a signal that this is a market that really is being affected by this? And being affected maybe in a larger way than the headline oil price might suggest? Martijn Rats: Oh, clearly. Look, the oil market is full with small price signals that tell the story of the underlying plumbing of the oil market. So, you can look at price differential. So, physically delivered cargoes versus financially traded futures. West African oil versus North Sea oil. Brazilian oil versus North Sea oil. Oil for immediate physical delivery versus the futures contract that trades a month out. And many of those spreads have rallied to all time highs. That is no exaggeration. And so, in an underlying sense, the stress in the market is clearly there. It is just that in front of Brent futures, which is the world's preferred speculative instrument to express a financial view on oil. Yeah, there the impact has been slower to come. But you're now seeing a lot of Asian refineries bidding for crudes that are further away in the Atlantic basin. So, demand is spreading to further away regions. And that should over time still put upward pressure on Brent. Andrew Sheets: In our first conversation, you know, you had this great walkthrough of both just putting the scale of this disruption in the Strait of Hormuz into the global context. How many barrels we're talking about, how that's a share of the global market. Maybe just might be helpful to revisit those numbers again. And also, some of the mitigation factors. You know, we talked about – well maybe we could release reserves, maybe some pipelines could be rerouted. Based on what you're currently seeing on the ground, what is this disruption looking like? Martijn Rats: Yeah, so to put things in context, global oil consumption is a bit more than 100 million barrels a day. That number lives in a lot of people's heads. But if ...