With diesel fuel in the United States now at record highs, all options for bringing prices down must be considered. Analysts rightfully identify disruptions to tanker passage through the Strait of Hormuz as the main cost driver. Yet another, more easily rectified factor has gone largely unnoted. The divergence between the cost estimate of shipping goods on a route that goes through the Strait of Hormuz and the actual expense is quietly driving prices even higher.
The complexities involved here are worthy of having Margot Robbie in a bathtub to explain, as in The Big Short. Lacking that option, here’s a quick explainer.
Oil extracted from the earth needs a way to get from its source, say, in Saudi Arabia, to refineries and then ultimately to the places that sell its final iteration, such as diesel fuel (which, itself, is used to power trucks carrying goods and tractors used on farms all over the continental U.S.). It’s a journey of pipelines and large tanker ships.
The cheapest and fastest way to transport it in normal times is by ship, not pipeline. Thus, the restriction of traffic in the Strait of Hormuz — the only maritime gateway to the Persian Gulf, which conducts 25% of global seaborne oil trade — has a huge effect on prices. Less product arriving in markets means higher prices on what’s available.
But that’s not the only factor in how much a gallon of diesel costs at the pump. Part of the price is the result of agreements that were made before the oil was transported.
Here is where Margot Robbie, in a bathtub, would explain that, similar to the mortgage-backed securities that turned out to be filled with no-value subprime mortgages in 2008, the index that serves as a settlement reference for tanker freight derivatives has been basically based on vibes since the Strait of Hormuz shut down.
This index is called TD3C. It’s a daily benchmark rate posted by the Baltic Exchange for shipping crude oil on Very Large Crude Carriers on a specific route from the Middle East Gulf to China via the Strait of Hormuz. It represents the real dollars per day the ship’s owner would earn after costs if hired on a time charter (a period of time during which a ship’s capacity is rented) basis.
In normal times, this index is based on real data from ships making the trip. However, very few ships are actually sailing this route, and those that try may have wildly different times (and success rates) making the trip depending on what’s going on in the strait.
This is making the benchmark highly susceptible to manipulation and introducing uncertainty and dysfunction in the market, expressed as volatility, unprecedented price spikes, insane spreads on Worldscale estimates, and problems with liquidity in TD3C-referenced derivatives.
The Baltic Exchange refuses to rectify the situation. It won’t release its data behind the estimates. It can’t guarantee that illegal activity, such as paying bribes to Iran’s International Revolutionary Guard Corps, isn’t affecting the number, and it refuses to reanchor by settling TD3C against a route with real deals behind it, such as TD34 (the Gulf of Oman-China).
A broken benchmark undermines a tool the market uses to manage tanker freight risk, and that distortion passes straight through to the contracts settling on it.
Contracts using TD3C are ultimately costing consumers higher prices at the pump, up to $15-20 a barrel of freight cost. It could be considered a fee for unreliability, something that regulatory bodies exist to correct.
Just as oversight in the market could have caught and shut down the vulnerability of the 2008 mortgage-backed securities being garbage before it crashed the stock market and threw the world into a recession, oversight and intervention by the Commodity Futures Trading Commission in the U.S. and the Financial Conduct Authority in London could yet remedy this mismatch between estimates and reality, thereby lowering fuel prices.
These bodies must act. The CFTC has the emergency authority to direct the affected Designated Contract Markets to use TD34 to settle outstanding TC3C contracts until verifiable and consistent Gulf shipping transactions resume.
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The FCA similarly needs to exert its oversight authority to provide stability and certainty. In search of this, commodity trader Mercuria is suing the Baltic Exchange over pricing data that did not account for the reality of the Strait of Hormuz’s closure. Other companies are considering doing the same amidst a regulatory leadership void.
Regulatory actions may not solve the big problem with the Strait of Hormuz, but at least relevant markets can begin to function rationally again, bringing down some costs for consumers.
Capt. Bart Gonnissen is a senior maritime pilot in the Scheldt Estuary. A former Master Mariner, he holds master’s degrees in nautical sciences from the Antwerp Maritime Academy and in transport economics from the University of Antwerp.