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Prices Mixed - Speculation Higher - Dollar Stronger - Rig Count Lower
During the week ending January 16th, the spot month diesel futures price decreased by 3.74 cents per gallon (-2.20%) while the deferred months declined by 2 to 4 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at an 11.34 cent premium to the spot price, from a premium of 11.05 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 higher 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 16th, the spot month gasoline futures price increased by 3.56 cents per gallon (+2.69%) while the deferred months changed by +3 to -2 cents per gallon making the forward pricing curve virtually unchanged in level and generally less positively sloped. The one year forward price ended the week at a 13.33 cent premium to the spot price, from a premium of 118.36 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates higher demand expectations and lower inventory levels with respect to supply and demand in the short to medium-term.
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 12.66% year over year.
The attractiveness of making new hedges was unchanged as prices were mixed. 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, global production will begin to slow and demand will increase but not enough to offset the current surplus of production. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging may become more attractive.
Weekly US petroleum demand decreased by 0.62% during the week ending January 9th. Domestic demand is up 3.89% vs. one-year ago and demand is currently 7.75% over the five year average.
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 16th.
Below is the one-year chart of spot gasoline futures prices as of January 16th.
: : Inventories increasing by 11.49 million barrels while inventories were expected to increase by 7.21 million barrels on the week. The five-year average inventory increased by 1.84 million barrels. Inventories increased vs. the five year average and 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.
: : Chinese monthly imports for December rose to a record high of 30.4 million metric tons and represented a 19.5% increase over November. While this is interesting and indicates strong demand at the current low prices but it does not necessarily translate into demand for consumption but merely consumption for stockpiling. If stockpiling and not consumption, this is supportive of the market in the near-term but medium-term may be negative for price as the demand for building inventories at these prices decreases which would lead to lower prices.
: : OPEC cut its forecasted demand for their crude for 2015 by 100,000 barrels per day to 28.80 million barrels per day. OPEC produced 30.905 million barrels per day in January which is 2.1 million barrels per day more than the OPEC demand estimate. This is contributing to the oversupply problem.
: : Stock market decreasing by -1.24% on the week is negative for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by 0.64% to a new 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 16th.
Below is the one-year chart for the US dollar index as of January 16th.
During the week ended January 9th, total petroleum inventories increased by 11.49 million barrels vs. a five year average increase of 1.84 million barrels and vs. an expected increase of 7.21 million barrels. Inventories increased by 9.65 million barrels vs. the five year average. Total inventories stand at 768.0 million barrels, up from 756.5 million barrels at the end of the previous week. The five year average inventory is 717.2 million barrels, up from 715.4 million barrels at the end of the previous week.
Current inventories are 7.07% higher than the five year average, up from +5.74% 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 13th, the net speculative long position in petroleum futures was 232,014,000 barrels up 12,358,000 barrels (+5.63%) from the previous week. Speculation increased for the second week in a row and represents 30.21% of domestic inventories. Speculation is 23.51% below its one year moving average. The corresponding spot month diesel futures price on January 13th was 163.30 cents per gallon, down 9.32 cents from 172.62 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 62.89% 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 39.55% 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 203.68 cents per gallon or 40.39 cents per gallon more than current prices. The analysis would indicate that about negative 24.73% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 7 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 303 million barrels, which is down about 1 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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