US-Iran talks collapsed over the weekend with there being no deal as both sides could not see eye to eye on a nuclear agreement. Iran is not letting up on their control over the Strait of Hormuz. And so the US is now stepping up the aggression by introducing their own blockade on Iranian ports starting later today.
With the US escalating military tensions in the region, it is hard to see both sides coming back for another round of negotiations. But if that won’t happen, where do we really go from here?
It is either US president Trump is confident enough that they can blow Iran out of the water, quite literally, or someone has to back down and offer up a compromise of sorts. Otherwise, the existing status quo will have bigger consequences for markets in due time.
So far today, the broader market reaction is more of a case that “it could’ve been much worse”.
European indices are down around 0.7% to 1.0% while S&P 500 futures are down 0.6% on the day. Those losses are not that bad, all things considered.
It seems like market players are still looking to hang on to some hope that things will be resolved eventually. And that is more evident by the reaction in the oil market.
I warned last week already that there will be a reckoning to come once traders realise that a deal isn’t coming. And while oil prices did open with a gap higher today, there’s still a massive divide to get through in trying to price match with the physical market.
For now, we’re seeing WTI crude trade around 8% higher today at $104.50 currently. However, the North Sea Forties crude is physically hitting a record high above $148 on the day. Typically, the gap between the two sits somewhere around $2 to $5 under normal circumstances. As such, this over $40 gap represents a war premium that will eventually need to be closed one way or another.
Yes, they’re both different types of crude quality but the price difference is a clear indication that there is major dislocation in the market. And eventually, that has to be resolved with either WTI crude moving up massively to close the gap or the physical market price dropping hard to “normalise”.
And we won’t have to wait too long to find out.
As a reminder, the May contract for WTI crude futures will run off by 21 April. As things stand, the market is in an extreme state of backwardation. That especially with prices for the June contract trading even lower at around $96 at the moment.
It means that traders are still expecting the US-Iran conflict to settle down by next month and even more so later in the year. However, you have to think that the next one week is going to be a pure survival game more than anything else.
So, it is either going to be traders wait until the last minute in hopes of better US-Iran developments (so as to cause the physical market price to plunge) or those in short positions will have to rush to scramble to buy back contracts before the cutoff date.
The broader market reaction might not be that bad so far today. However, perhaps the worst is yet to come especially with likely a massive surge of volatility beckoning in the oil market in the next one week.
This article was written by Justin Low at investinglive.com.
