Gas Prices on the Rise: Understanding the Impact of Global Conflicts

Morning trade.

We are looking at WTI prices holding right below 116 cents a barrel with the contract higher by about 3%.

Of course, global markets are keeping an eye on Trump's deadline to reach a truce with Iran.

And oil prices climbed this morning after reports that the US struck military targets on Car Island.

Well beneath the headlines a major structural shift is happening and that is the historic pricing spread between W with the US inflation data looming this weekend and rate cut that's fading.

Joining us to discuss what we're seeing in.

Oil prices is Stephen Schork, principal of the Schork Report.

Stephen, good morning.

Thank you so much for joining us.

Well, first, let's start with what we're seeing in terms of the broken spread.

So historically, WTI trades at a discount to Brent because it is landlocked and lacks the same global reach.

So what are we seeing right now and what are your models telling you?

Yeah, absolutely.

So right now, to your point that the US market, the WTI market is a landlocked market with the terminal complex in the middle of the country in Cushing, Oklahoma, whereas Brent is hooked to the North Sea production.

Uh, what we're seeing now with the disconnect is the asymmetric, uh, volatility in this market.

So at this point, we're seeing an extreme bid for Asian oil where we saw oil in Asia hit $170 a barrel at a time when WTI was trading at $95 a barrel.

And the same with Brent crude oil now.

So both markets, whether we're looking at Far East crude or uh North Sea crude, is trading at an extreme premium to WTI.

So delivered.

US production into the Gulf Coast is yielding at the cost, about 7 to $8 risk-free profit.

So what's happening now is the US is the world's marginal producer, so all extra demand is coming to Gulf Coast, which is linked more towards the WTI market.

So we're seeing extreme evidence of physical demand both from Asian refineries and both from European refineries that are coming to the cheapest.

Barrel in the world that is Gulf Coast oil linked to WTI.

So what we're now seeing is a market WTI that was inoculated to an extent for the 1st 4 weeks of this conflict because it was landlocked.

But now because it's the cheapest barrel, that demand is now coming to the Gulf Coast of America and now pulling WTI prices, and WTI prices are catching up.

Remy, I also want to point out though what we're looking at here.

Is the May contract for WTI opposed to the June contract for Brent.

These are the two prompt contracts.

The May contract expires in 2 weeks as opposed to 3 weeks for the Brent contract.

So this, there's more asymmetry in the May contract because it goes off the board faster.

If we look at the July, well, the June contract against the June contract, the corresponding months.

Brent is still maintaining a substantial premium to WTI.

So what we're seeing is a short-term disconnect because of asymmetric volatility related to the headlines, I believe, that is now has WA trading at a premium to Brent. and Stephen, while I have you here for our viewers who are watching right now at the nation's airport gates and wondering why we're continuing to see this rise in the average price of a gallon of regular gasoline.

What would you say to them and can you tell us how you're pricing in extreme geopolitical tail risk when it comes to your forecast.

Yeah, absolutely.

So we're using geometric jump diffusion models which are probability-based models based on volatility.

In a situation like this where we really are in uncharted waters, so there's a little bit of fudge work that you have to do.

So we've doubled our jumps, we've doubled our potential volatility, the probabilities.

So looking at where nonex gasoline had traded up to last Friday, we were projecting between the war premium and the normal uptick in the price that we see when we switch from a winter.

Grade gasoline, the summer grade gasoline, which we're in the process of, that we were looking at a national average of about $4.25 a gallon.

Now, of course, we've seen substantial rises there.

So I don't think at this point, the prices that we saw three years ago, uh, for one week, we saw a national average of $5.

I'm not going there yet, but considering that I do not believe this conflict, I, I do believe this conflict is going to get worse before it gets better, i.e.

To see a greater disruption to the flow of oil that certainly sets the table for higher oil prices.

Right now our WTI price is halfway between our two first standard deviation envelopes, between $102 and $134 a barrel.

We're right at about $116.

We're halfway there.

What that's going to correspond to in gasoline for the retail pump, certainly we can expect to challenge that $5 premium in about a month's time. and Stephen, of course we'll be paying attention to those inflation figures we'll be getting out this Friday, Friday morning in terms of how inflation is affecting Americans, but OPEC plus is warning that recent attacks like the damage to Kuwait's oil headquarters will disrupt supply long after this conflict ends.

So how are you pricing and structural supply deficits regardless of an eventual ceasefire?

Yes, absolutely.

So at this point, the main trigger point is of course disruptions to the flow of oil through the Strait of Hormuz.

But what's not being factored in is to the lasting damage both in crude oil and more so in natural gas, and I think that's really where the hammer is going to drop.

So right now, let's be clear, there's from a US perspective, from a WTI perspective, even though it's trading at That premiums to oil supplies here in the United States are at 3-year highs.

So we are, we are at some of the highest highs for our supplies that we've ever been.

So there's plenty of oil in the stock market right now.

So what this is telling us is that there's an extreme risk premium being priced into the front end of the curve.

As we go out further along the curve, prices do moderate, but A longer term out, say a 2-3 year factor that we have to factor in where the spreads are trading and the loss of production.

We're looking at a long term price of oil before the conflict, which was trading upwards of about $60 a barrel.

That's been lifted now.

So we're looking at higher prices, i.e., $80 a barrel.

Assuming we get some sort of resolution over the next 34 or 5 weeks to this.

So at the current environment we're looking at, we're pricing, yes, in the stock market, $134 a barrel, and I don't even want to tell you what the third standard deviation is, but it's a really ugly number.

But I also want to emphasize that we can get there.

I mean, we're already looking at oil, diesel fuel trading at well over $180 a barrel, so we're up at levels that Two things have to happen.

Supply has to come to the market to take advantage of that price, or we need to see demand destruction.

Well, the longer this conflict lasts, the likelihood of more supply being able to state this price rise is limited.

So therefore it has to come on the other side, and that is demand destruction.

That's exactly what we saw in 2008 when oil prices were at $150 a barrel.

A couple of months later, the Great Recession really digs in, and 6 months later, oil trades from $150 down to below $40.

I hate to interrupt you, but we will have to leave it there for today.

So thank you so much for joining us.

I appreciate your time as well as all of your insights.

Thank you.