Oil Futures Prices Divorced From Physical Markets For Now

Tyler Durden's picture

Submitted by Peter Sainsbury via OilPrice.com,

“Like pushing a rock up a hill”

That’s how some trader’s view the current disconnect between the physical market for crude oil and the futures market with speculators pushing futures prices higher while the physical market remains moribund.

Before continuing, 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 a means for trading the probability of where crude prices will be at certain points in the future; this allows physical market participants a means by which they can hedge their position and so reduce risk.

The physical crude market tends to show weakness (i.e. too much crude swashing about) when the premium for the best crude grades weakens against the benchmark Brent. One of the most favoured grades in Europe is Azeri Light due to its high quality.

Over the past couple of months physical crude traders have noted the weak premiums for Azeri Light versus Brent as other cargoes, particularly from West Africa compete to supply crude into an already oversupplied Atlantic Basin market.

This apparent disconnect between the futures and the physical market appears eerily similar to mid-2014, just prior to crude prices collapsing. So is the current weakness in the physical crude market a precursor to an imminent weakening in crude futures prices?

Don’t bet on it - at least not based solely on what the physical market is doing.

While the physical fundamentals of supply and demand prevail eventually, the physical market may not always be able to anchor futures prices for days, months or even years.

If commodity futures prices rise too much, perhaps as a result of speculative interest, as there is now, physical supplies will start to be delivered against short positions (a manufacturer looking to hedge its inventory of raw materials might have this kind of position).

In practice, there is never enough physical material readily available to deliver against all the short positions, so rising futures prices can only be offset by buying back crude futures contracts rather than making physical delivery. It takes time to divert and accumulate sufficient physical crude supplies to meet a rise in futures prices driven by speculative rather than fundamental factors.

To get an idea of the extent to which this process is occurring take a to look at the net contract short position for commercial hedgers from the US CFTC weekly Commitments of Traders report. Back in mid-2014 the net short position amongst commercial hedgers (actual producers and users of crude) rose to around 500,000, a record level. This position has since fallen to just over 300,000, but it is still high on an historical basis.


As we know from the months leading up to the oil market crash that began in the middle of 2014, oil futures prices can divorce themselves from the physical fundamentals for a long time.

The price of crude, as with any other commodity is only worth what someone is prepared to pay for it. The market’s perception of scarcity in mid-2015 is such that participants in crude futures markets are now willing to pay less than half what they were paying just one year ago.

While theory suggests crude futures markets are anchored to the physical market as contracts expire, in reality the link is a lot more tenuous. As with the myth of Sisyphus the rock will eventually start to roll back. Timing when that will take place, and the catalyst involved, is a whole different matter.

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VinceFostersGhost's picture



And what caused the huge spike in oil prices? Take a wild guess. Obviously Goldman had help — there were other players in the physical-commodities market — but the root cause had almost everything to do with the behavior of a few powerful actors determined to turn the once-solid market into a speculative casino. Goldman did it by persuading pension funds and other large institutional investors to invest in oil futures — agreeing to buy oil at a certain price on a fixed date. The push transformed oil from a physical commodity, rigidly subject to supply and demand, into something to bet on, like a stock. Between 2003 and 2008, the amount of speculative money in commodities grew from $13 billion to $317 billion, an increase of 2,300 percent. By 2008, a barrel of oil was traded 27 times, on average, before it was actually delivered and consumed.



Which is worse - bankers or terrorists's picture

I find it cute and endearing when we talk about "markets" here, like they still actually exist. 


CarpetShag's picture

Right, like when in July 2008 and July 2014 the demand for crude oil suddenly dropped below the supply

edit: and this joker quotes a CoT report ?......

KnuckleDragger-X's picture

Don't mistake one thing for another. Cushing basically rents tank space for producers and from there it is delivered to a refiner on direct contract or put on the futures market. The refiners try to buy futures at best price, but "the markets" see the contracts as chips in the game and plays accordingly. Somebody is going to get bent over, but there are still some sheep left.....

sun tzu's picture

That simply shows oil was massively overpriced both times. 

post turtle saver's picture

yet again, I remind everyone of the ICE cartel, its control of the Euro supply chain, and subsequent manipulation of the Brent index when Brent was hitting its peak... Goldman Sachs being one of the key members of ICE... q.e.d.

pndr4495's picture

The most powerful bit of information in trading is KNOWING other traders' positions in the market being traded. Ask SEMGROUP and their former CEO who knew what their position was and how that information was used against them. Who was their primary NYMEX clearing agent, for example?

Lazane's picture

nothing new here, disconnected manipulation its what is allowed in order to continue the ponzi scheme operated in all the markets. If you don't hold it, you don't own it.

VinceFostersGhost's picture



No worries, the 93 million jobless and 29.5 hr/wk workforce are sure to keep this ponzi going.


They've got money coming out the wazzoo!

Navymugsy's picture

Hey oil traders: Welcome to the gold/silver markets! How does it feel to get paper rammed up your ass in lieu of physical delivery?

Herodotus's picture

It starts out as Arab oil and by the time the speculators are done it has been transformed into Jewish oil.

Atomizer's picture

Watch for Jewish Lightning. Not kidding. 

adr's picture

A near worthless rock is transformed into something worth thousands of dollars after it passes through Jewish hands.

All of these commercials tell me that I don't love my wife unless I pay thousands of dollars for a polished common piece of carbon.

The Jewish middle man premium has accounted for at least 50% of inflation over the past sixty years. What am I saying, the Jewish middle man premium has accounted for 100% of inflation.

sun tzu's picture

NOt completely worthless. They're good for use as drillbits. 

Atomizer's picture

Darkpools/HFT. We must rewrite our source code. 


buzzsaw99's picture

The Congress established the statutory objectives for monetary policy--maximum employment, stable prices, and moderate long-term interest rates--in the Federal Reserve Act.

stable prices, lulz. epic fail. the fed doesn't want stable prices in ANYTHING. pump and dump bitchez.

CarpetShag's picture

Questions raised by this post:
- how is the "immediate delivery" price determined (doubtless "fixed"), where and by whom
- what is "immediate delivery" - same day? same week/ month?
- dependence of "immediate delivery" price on amount purchased?
- which entities buy and sell using the "immediate delivery" price. Are they the ones that load up storage tankers?
- difference between the "immediate delivery" price and that of the nearest futures contract?

As always, it is completely futile to imagine that one has a full picture of the supply and demand factors. Leave that to the bankers.

sun tzu's picture

physical markets determined by buyer and seller with no futures traders or wall street involved


look at the plains all american or other midstream websites for the physical markets


fremannx's picture

OIL has a long way to go to find its ultimate bottom as this analysis has accurately predicted so far...


Return of 20-20's picture

Could be the rise is based on the reading of the mideast tea leaves where turmoil rains supreme.  wouldn't take much to majorly curtail oil output due to production/delivery issues caused by bombs, blockades etc.  In the end it might by a silly bet but the chances of a major dislocation is not 0%.

adr's picture

But when retail prices are based on what the futures contract trades at, who cares what the cash market price is.

RBOB was linked to Brent for some reason even though most US refiners don't use Brent. So why is our retail gasoline price linked to a futures contract and not to what refiners actually pay for oil?

Everything points to the futures market essentially being nothing but a system for big speculators to scam money. It serves no purpose and never really has. The idea of hedging was sold as a way to guarantee prices so cash flow could be smoothed out and planned in advance. Instead hedging increased prices across the board. Just like utility deregulation. All of a sudden I could buy natural gas and electricity from hundreds of different companies, but none of them actually produce or deliver gas or electricity. They only buy the right to sell a contract for it. With all the new competition in the contract market prices skyrocketed. When nat gas contract was trading for $1.80 we still had to pay over $5 for delivered gas. 

Wow, who would of thought adding thousands of middle men would increase prices? It is called the nomatter what is made on Earth, Goldman wants its cut effect.

Crocodile's picture

Prices we pay for all things are determined by those with power, influence and resources. (Industrial/corporate complex)  If demand is weak, then they interrupt supply in both the paper and physical markets as needed using war, both overt and covert, and that formula is used all the time.  How are corporate profit margins so high and have been during a time of ongoing recession?  They determine what we will pay until we reach "critical mass" when we can no longer buy at any price.  We are well on the way there and many are already there. How many people are one medical crisis away from potential bankruptcy at worse or at least ruining their credit?

donupstream's picture

ZeroHedge there you go again with a down with oil article. You guys are the Dennis Gartman of free press.

oddjob's picture

No shit, the jawboning on Oil on ZH is in bubble territory.

post turtle saver's picture

the stream of news related to this topic has been strong and steady ever since Russia got kicked in the teeth with a 60% price drop... it won't stop until it's back to $100+ a barrel again and Pooty Poot can finance his dreams of Euro domination once more...

if you don't believe that, I recommend looking at when this daily stream of oil price news started in earnest and the RTHedge crowd realized just how painful that was going to be for Fearless Leader...

sun tzu's picture

LOL you Yellen PMSNBC cocksucking pumpers are pathetic. 


The Russian markets and currency have outperformed the dollar and Euro all year long. When is Putin going to be overthrown? When will the Russians come begging on their knees for forgiveness? That was supposed to happen last fall, right?


US military has troops in over 100 countries and the CIA monkeys expect us to believe Russia wants world domination

post turtle saver's picture

you are a fucking idiot...

wars run on money... Putin was begging friend and enemy alike to repatriate money into Russia when this all went down... they had severe cash flow problems and they knew it...

it's easy to outperform when there's nowhere to go but up and, like most shit talkers on this board such as yourself, you can pretend to have bought at the bottom... here's a news flash, most didn't and they're staring down the barrels of this:




no you tell me, genius... if you're planning your govt's budget on $110 oil and it drops like a rock to $55 or less, what does that do with your oh so precious plans? I'll tell you what it does, it throws a king sized monkey wrench into them that makes you have to crawl back on the hope of +100% gains just to get back to where you started... well, guess what, it's not there yet... not even close...

who gives a flying fuck if Putin is overthrown? it's not necessary, hell keep him in place, it's perfect since we already know how he's going to react... basically, like the one trick pony he is... high oil price or nothing...

you can shit in one hand and wish in the other and I can tell you which is going to fill up faster... so keep on wishing...

Youri Carma's picture

For some reason oil is closely related with the economy and one of it's main fundamentals. Donnow why because I am stupid.

RealistDuJour's picture

Apparently "catalysts" are only negative for the price of oil.  *cough* ISIS/RSA *cough*.  Sorry I'm allergic to shitty hack pieces and $48 handle calls.

roadhazard's picture

Is it "Peak Oil" yet, dad.

Quinvarius's picture

Oil traders need to learn what has been obvious to gold traders for a while.  There is no connection between paper markets and phyical markets except in the extremely long term.  The bankers, Fed and governments will sell every barrel at 50 cents or 100 dollars.  The end result is the same, they sell every barrel.  The people setting the prices don't make the product, can sell or buy as much paper as they want, and can absorb or fund any margin call.  The only place you are going to see anything is in the real world when supply runs out.

No one ever said the government and CBs could not fix prices--Only that none of us could escape the punishment and consquences for doing so.