Welcome to another edition of the Fans Week Podcast, also on mediumwaves 1575 KHz. From Paris I’m Ami Carter-Wilson.
The Situation
• The Iran conflict has effectively closed the Strait of Hormuz, removing from supply approximately 12 million barrels per day — roughly 12% of global petroleum throughput.
• Physical Brent crude touched a delivered spot near $150/bbl before retreating on ceasefire announcements; latest settlement reads cluster $88–$98. The move was not orderly.
• Europe faces ~six weeks of jet-fuel inventory per IEA’s Fatih Birol. Lufthansa is accelerating schedule cuts. KLM has already cancelled 160 flights. Air France-KLM, having hedged 87% of required exposure, continues to cut capacity.
• Nordic and Northwest European jet fuel imports fell 15% in April. The final Hormuz-transiting cargoes have arrived; no remaining physical arbitrage enters the region.
• U.S. export flows have pivoted Pacific: Asia now absorbs 30%+ of American jet-fuel tonnage, leaving Europe competing for residual volumes in a fractured spot market.
• Europe has shuttered 28 refineries since 2009 — ~16% of installed processing capacity — further compressing the region’s ability to substitute feedstocks under stress.
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What this episode illuminates is not merely a supply shock but the failure of conventional term-structure models to price the convexity inherent in strait-based commodity risk. Standard backwardation diagnostics — Schmalensee & Friedman (1982), Working (1949) — treat spatial dislocation as a mean-reverting spread. Hormuz is not mean-reverting. It is binary: open or closed. The stochastic discount factor, in Harrison & Kreps (1979)’s sense, becomes regime-dependent rather than continuously defined.
Consider the options literature most applied to this domain. Pindyck (1988) modeled flexible capacity as an American option under Geometric Brownian Motion; Gibson & Schwartz’s (1990) two-factor model adds a convenience-yield mean reversion with exponential decay. Neither framework accommodates a regime where physical access is extinguished entirely. The term structure of Brent options, which normally encodes market expectations about forward scarcity, instead encoded an implicit assumption that Hormuz remained navigable — an assumption now void.
CDS markets on hydrocarbon-sector names have responded with expected widening: BBB-rated majors in refining and distribution show spread expansion of 150–300 bps. Acharya & Richard (1989) demonstrated theoretically that CDS prices embed convex options on default probability under stochastic rates. That convexity, multiplied by the binary nature of Hormuz risk, produces a feedback loop in which funding costs become endogenous to physical trade — precisely Breen et al. (1996) warned about when they argued linear no-arbitrage models fail under commodity illiquidity.
The Schwartz-Smith (2000) two-factor representation collapses when convenience yield is not continuous but an indicator variable {0, 1} depending on whether shipping lanes are passable. In that discontinuous environment, risk-neutral densities from options prices (Carr & Madan, 1998; Rubinstein, 1994) become artifacts: they presuppose a measure under which all states remain accessible. Hormuz violates the assumption.
Duffie & Singleton’s (1999) framework for credit risk combined with commodity spot dynamics predicts exactly the cascading failure in European refining spans today — but was calibrated on continuous-time data from an era of open corridors. The Scholes (2000) lectures similarly assumed put-call parity holds for physically-settled commodities; parity vanishes under spatial rationing when you cannot deliver what you have sold.
Cochrane (2015) argued commodity risk premiums are mean-variance hedging demands; Huntington (2008) showed inventory-to-use ratios track oil prices with structural rigidity. Both presume linear substitutability across geography. When 16% of European capacity is offline and the last Hormuz shipment sits in a Rotterdam terminal, substitutability reaches its bound. The market is not pricing scarcity — it is experiencing liquidation under regime shift.
And yet, what does any academic economist actually do when confronted with a binary geopolitical event that renders their models structurally invalid? We produce working papers. We refine calibration procedures. We write footnotes explaining why forward curves have flattened into incoherence and then publish the result in a journal that no one reads past its abstract. The Strait of Hormuz does not care about our hazard rates or stochastic discount factors. It is closed, or it is open — and the mathematics, as ever, arrives late.
— A. Carter-Wilson writes The Wall Street Journal’s column on world economics.