The Federal Reserve Board published a staff FEDS Note examining how the Middle East conflict and closure of the Strait of Hormuz have affected the reliability of oil futures as indicators of expected spot prices. The analysis finds that severe supply disruption has produced exceptional backwardation, with spot prices far above futures prices, and likely pushed oil risk premiums into negative territory since March. As a result, futures prices are likely to overstate investors’ expectations for spot prices at contract expiry. A model using West Texas Intermediate crude oil data since 2000 estimates average risk premiums during the conflict at negative 5.4% for three-month futures, negative 4.3% for six-month contracts and negative 7.6% for one-year contracts. Oil futures positions may now serve as a hedge against near-term macroeconomic risk, while demand for protection against further oil price increases adds upward pressure to futures prices relative to expectations. Market liquidity has also deteriorated across maturities, with suppressed top-of-book depth persisting for more than five months through July and likely increasing liquidity premiums. The note cautions that the estimated premiums rely partly on extrapolation because the degree of backwardation from March through May was nearly unprecedented in the 26-year dataset.
Federal Reserve Board staff analysis finds oil futures likely overstate expected prices during severe supply shocks
Federal Reserve Board staff analysis finds that severe oil market backwardation during the Middle East conflict has likely made risk premiums negative, causing futures prices to overstate expected spot prices. Estimated premiums range from negative 4.3% to negative 7.6% across three-month to one-year contracts, while prolonged low liquidity adds further distortion.