Price at the pump

The market price of oil is set by futures markets and physical spot markets that clear off them.

Brent futures and WTI futures trade 24 hours a day, with millions of contracts changing hands daily. The front-month futures price is what news outlets quote as the "price of oil." This price clears at the level of the last marginal buyer and seller — physical hedgers (refiners, airlines, producers) and speculators. The contract is liquid and electronic, so it reprices within milliseconds of news.

Physical spot markets refer to the 40M barrels of physical crude that change hands daily (actual cargo, loading at ports). Each crude grade trades at a differential to Brent or Dubai, based on quality and location. Agencies collect bids and offers from traders and publish a daily "Dated Brent" assessment (official benchmark).

So when Brent moves 5% in an hour, every physical cargo loading that day reprices accordingly.

Let's say a shock event occurs. Futures reprice within minutes, and the marginal-barrel value resets. Spot physical reprices on the same day. However, it takes days to weeks for this price to reach refiners. Refiners are still consuming inventory they purchased at the old price. New cargoes arrive over 2–6 weeks. As refiner costs rise, they lift rack prices at terminals where tankers are loaded. The crack spread (refining margin = gas price − crude cost) often widens during a shock, as refiners price aggressively to recoup feedstock costs. Wholesale gas prices update within days. Finally, retail stations buy from the rack, sit on thousands of gallons of inventory, and reprice based on their costs and local market. Some stations adjust faster than others. The EIA data presented on this website show the latter half of the price effects.

The Strait of Hormuz is the global chokepoint through which ¼ of seaborne oil flows. Bypass capacity is small. Iran can close the Strait, either through mines or by making ships too expensive to insure. Removing the un-bypassable share of oil from the global market looks like a 13% supply shock. Before the Iran War began, the global price of oil was ~$70. It went over $100 mere weeks after. This takes longer to show up at the pump.

Prices can increase because of supply shocks and demand destruction, and these effects can cause one another. We can try to disentangle the dominant effect through the data.

In a supply shock, there is less available oil. This looks like backwardation (front-month > deferred) in crude futures. Spot scarcity bids up the nearest contract. Refinery utilization is high, and the crack spread widens (gasoline rises faster than crude).

In the case of demand destruction, prices are so high that consumers buy less (or are forced to). Crude futures are in contango (front-month < deferred). Barrels are not finding buyers. Inventories build as prices fall, and refinery utilization drops. The crack spread narrows.

Right now, supply-shock dominates. We only hope that the demand effect does not become so severe as to be the one moving prices.