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Prices Down - Speculation Higher - Dollar Stronger - Rig Count Lower
During the week ending January 9th, the spot month diesel futures price decreased by 9.27 cents per gallon (-5.16%) while the deferred months declined by 8 to 12 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at an 11.05 cent premium to the spot price, from a premium of 12.68 cents at the end of the previous week.
The change in level and slope of the diesel forward pricing curve indicates lower demand expectations and higher supplies with respect to demand. Demand includes speculative demand which was lower on the week. When the forward pricing curve decreases in slope (more negative or less positive), this usually indicates tighter inventories and is generally positive for price. When slope increases, this usually indicates more plentiful inventories and is negative for price.
During the week ending January 9th, the spot month gasoline futures price decreased by 11.02 cents per gallon (-7.69%) while the deferred months decreased by 6 to 11 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at an 18.36 cent premium to the spot price, from a premium of 17.71 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and higher inventory levels with respect to supply and demand.
The US dollar increased on the week which is negative for price. Inventories on the week were higher which is negative for price. The stock market, as a proxy for demand expectations, was lower which is negative for price. Speculation was higher on the week which is positive for price. US domestic crude production was higher on the week which is negative for price. Domestic production is up 12.11% year over year.
Weekly US petroleum demand decreased by 2.98% during the week ending January 2nd. Domestic demand is up 2.64% vs. one-year ago and demand is currently 9.92% over the five year average.
The attractiveness of making new hedges was higher on the week as prices were lower. From a flat-price basis, prices remain very attractive at five-year lows. The market should find medium-term support at current prices since prices are very near to the marginal cost of some production which will act like a price floor and mitigate the risk of significant opportunity cost in new hedging. In the short-term as global production begins to slow but has not declined enough to offset the current over-supply, spot and nearby prices can move lower while prices further forward on the curve will not move lower as quickly. This will cause the forward pricing curve to become more positively sloped as we have seen. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging may become more attractive.
Domestic production was slightly higher on the week to a new 40 year high level. The number of operating oil drilling rigs in the US continues to decline and the decline is accelerating. This will limit production growth and may cause sustained declines in production which would help in balancing supply and demand in the market.
Below is the one-year chart of spot diesel futures prices as of January 9th.
Below is the one-year chart of spot gasoline futures prices as of January 9th.
: : Inventories increasing by 16.26 million barrels while inventories were expected to increase by 6.55 million barrels on the week. The five-year average inventory increased by 10.38 million barrels. Inventories increased vs. the five year average and decreased vs. expectations.
: : The market continues to be oversupplied by about two million barrels per day. Until the market solves this problem through price adjustments to decrease supply and/or increase demand to absorb the excess, prices will remain low and the forward pricing curve will remain significantly positively sloped.
: : Russian production rose by 0.3% to a post-Soviet high of 10.667 million barrels per day. Iraq rose to a level of 2.94 million barrels per day in December, the highest level since the 1980's.
: : Worse than expected US economic data: November factory orders and the December non-manufacturing index from the Institute of Supply Management were both weaker than expected signaling some weakness in the US economy which is negative for petroleum demand expectations and price.
: : An unexpected decline in UK and German November industrial production showing continued weakness in the European economy. This is negative for petroleum demand expectations and price and is also positive for the dollar which is, in turn, negative for petroleum prices.
: : Stock market decreasing by 0.65% on the week is negative for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by 0.94% to an eleven year high. This is negative for petroleum price. Commodities are used as a hedge against inflation and against a falling dollar. A stronger dollar reduces the relative demand for commodities for this purpose and prices decrease accordingly. Conversely, a weaker dollar increases relative demand for commodities and prices increase.
Below is the one-year chart US stock market prices as of January 9th.
Below is the one-year chart for the US dollar index as of January 9th.
During the week ended January 2nd, total petroleum inventories increased by 16.26 million barrels vs. a five year average increase of 10.38 million barrels and vs. an expected increase of 6.55 million barrels. Inventories increased by 5.88 million barrels vs. the five year average. Total inventories stand at 756.5 million barrels, up from 740.2 million barrels at the end of the previous week. The five year average inventory is 715.4 million barrels, up from 705.0 million barrels at the end of the previous week.
Current inventories are 5.75% higher than the five year average, up from +4.99% at the end of the previous week. Inventory levels are growing due to excess supply and low price where those who hold inventories are accumulating more which is essentially increasing a long position in the market. Those who hold inventories have an incentive to do so since forward prices are higher than spot prices, holders of inventory can earn an attractive guaranteed return on their investment.
As of January 6th, the net speculative long position in petroleum futures was 219,656,000 barrels up 3,129,000 barrels (+1.45%) from the previous week. Speculation increased for the first time in three weeks and represents 29.04% of domestic inventories. Speculation is 27.76% below its one year moving average. The corresponding spot month diesel futures price on January 6th was 172.62 cents per gallon, down 14.26 cents from 186.88 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 64.27% correlated over the past 52 weeks (a decrease on the week as prices continue lower but speculation remains relatively high) indicating that, on a statistical basis over the past year 41.31% of the price movement of diesel fuel is explained by changes in levels of speculation. A linear regression analysis over the past 52 weeks shows that if speculation were zero and the market forces causing speculation evaporated, that the spot month diesel futures price would be 210.15 cents per gallon or 37.53 cents per gallon more than current prices. The analysis would indicate that about -21.74% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 6 cents lower on the week.
The net speculative long position has been variable over the past year ranging between 166 million and 453 million barrels with an average of about 304 million barrels, which is down about 2 million barrels on the week.
Linwood Capital, LLC is an institutional fuel hedging management, advisory, and consulting firm. Linwood creates and manages customized fuel hedging programs for institutional consumers of petroleum and natural gas.
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