Crude oil drops, but physical tightness tells a more cautious story

Disclaimer: This article is written by KaynatChainwala, AVP Commodity Research at Kotak Securities. Views expressed are his own. Readers' discretion is advised. September has compressed an entire cycle of escalation and relief into four weeks, and the numbers tell that story more precisely than the headlines do. Brent surged from near $90 at the end of August to $110 in the second week of the month before retracing to below $98, as UNGA diplomacy and early signs of Saudi supply recovery began unwinding the premium that conflict escalation had built. WTI has tracked the move lower, trading near $89. The magnitude of both moves suggests that positioning and momentum amplified the underlying fundamental shifts. The strongest evidence of physical tightness came during the peak escalation phase. The EFP, the premium of physical Dated Brent barrels over futures, surged from negative territory at the end of August, when the spot market was flooded with supply diverted from blockaded routes, to nearly $25 at the height of the conflict's expansion into Saudi infrastructure, a swing of more than $25 in under three weeks. The Brent 1-to-12 month backwardation widened from $13 at end-August to nearly $29 at its peak, the most acute near-term scarcity signal the market has produced in this cycle. Vessel traffic through the Strait of Hormuz, which had averaged 16 ships per day before the conflict, compressed to between one and five ships through most of September and has shown no meaningful recovery, with daily counts remaining at two or fewer through the current week. These were not risk-premium metrics. They were physical tightness metrics, and the market was right to price them aggressively. Net long contracts in crude futures built to over 135,000 by mid-September as momentum-driven buying chased prices higher, leaving the trade structurally overextended. When the immediate supply scare began to fade, that positioning unwound sharply. The subsequent decline has been steeper than the physical developments alone would justify, with profit-taking and fresh short-selling combining to accelerate a move that the diplomatic and supply signals had only partially warranted. The physical recovery that has provided genuine fundamental justification for lower prices is the Saudi East-West pipeline restart. The pipeline, which has a capacity of up to 7 million barrels per day and had been routing approximately 4 million barrels per day, or roughly 4% of global supply, around the Hormuz chokepoint to Yanbu, was forced offline following drone strikes earlier in the month. Saudi Arabia has now restored operations and is targeting a resumption of Yanbu exports imminently, while simultaneously rerouting crude through Hormuz at approximately 2.9 million barrels per day over the most recent six-day period, up sharply from around 700,000 barrels per day in August. That supply normalisation is real and material. 

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 The physical market has not yet confirmed, however, that the de-escalation being priced into futures is durable. The EFP, despite falling from its $25 peak, remains elevated at $17, a level that continues to signal significant spot market tightness relative to paper. Backwardation has narrowed from $29 to $18.46 but remains historically steep, continuing to indicate materially tighter prompt physical availability than headline futures prices suggest. Hormuz vessel traffic has not recovered. The IEA's latest assessment projects global oil demand to fall by 2.5 million barrels per day in 2026, approximately 940,000 barrels per day more than its prior estimate, a figure that captures the conflict's economic weight on consuming nations. Yet against a supply backdrop this disrupted, demand destruction alone does not resolve the tightness. Logistics remain strained, with longer routing, higher freight and insurance costs, and tighter availability of certain grades keeping delivered costs elevated. Product markets, particularly diesel, still reflect a refining environment that would historically be consistent with much higher crude levels. The backwardation and EFP are not simply lagging. They are pricing frictions that the headline price has already discounted. The diplomatic picture adds further uncertainty. Trump described his meeting with Iran's delegation at the UNGA as very good and indicated further discussions are scheduled, while Qatar has confirmed active back-channel communications between Washington and Tehran. Trump has simultaneously indicated that a broader settlement is unlikely before the November midterms, a structural constraint that limits how far the diplomatic calendar can advance in the near term. The Trump-Xi summit, with Treasury Secretary Bessent expected to press Beijing on enforcing Iran sanctions given China's role as the largest buyer of Iranian crude, adds another variable that could cut either way. US Strategic Petroleum Reserve levels at 284.6 million barrels, the lowest since October 1982, mean Washington retains little buffer if the supply picture deteriorates again. The market appears to be pricing a smooth path to de-escalation. The physical signals suggest that path has several unresolved steps ahead of it. What makes the current positioning particularly consequential is that speculative length, while trimmed from its mid-month peak, has not been fully cleared. A diplomatic setback, a fresh Hormuz incident, or a stall in the Saudi pipeline restoration would not simply reverse the fundamental case for lower prices. It would collide with a market that moved 20 per cent in under two weeks on the way up and is structurally capable of doing so again. If the pipeline restoration completes on schedule and diplomatic momentum from UNGA holds, Brent has room to ease further toward the $94 to $96 zone. A reclaim of $100, however, would signal that the risk premium is rebuilding and shift the bias back toward the upside. On the daily chart of MCX Crude Oil Futures, the broader structure remains constructive within a rising channel, although price has entered a sharp corrective phase from the recent high near ₹10,000. The recent decline has weakened short-term momentum, with price retreating toward the lower half of the ascending channel. RSI at 45.38 has slipped below its signal average, indicating fading momentum and a near-term corrective bias. Immediate resistance is placed at ₹9,158, followed by ₹9,500, while key supports are positioned at ₹8,035 and ₹7,862. The rising channel support remains important for preserving the broader bullish structure; a sustained break below 7,862 would weaken the setup materially. Near-term bias remains corrective-to-neutral below ₹9,158, with recovery above this level required to revive upside momentum toward ₹9,500.