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Prices Lower - Inventory Higher- Dollar Stronger - Rig Count Lower
During the week ending January 23rd, the spot month diesel futures price decreased by 1.89 cents per gallon (-1.13%) while the deferred months declined by 2 to 3 cents per gallon making the forward pricing curve lower and relatively unchanged in slope. The one year forward price ended the week at a 10.62 cent premium to the spot price, from a premium of 11.34 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 steady 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 23rd, the spot month gasoline futures price decreased by 1.09 cents per gallon (-0.80%) while the deferred months decreased by 2 to 4 cents per gallon making the forward pricing curve lower and relatively unchanged in slope. The one year forward price ended the week at an 11.66 cent premium to the spot price, from a premium of 13.33 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and steady inventory levels with respect to supply and demand.
The US dollar increased sharply 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 higher which is positive for price. Speculation was lower on the week which is negative for price. US domestic crude production was lower on the week which is positive for price. Domestic production is up 14.08% year over year.
The attractiveness of making new hedges increased as prices were lower and speculation was 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, 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 increased by 5.10% during the week ending January 16th. Domestic demand is up 4.89% vs. one-year ago and demand is currently 5.31% over the five year average.
Domestic production was slightly lower on the week. The number of operating oil drilling rigs in the US continues to decline and the decline is accelerating. During the week, the number of operating rigs in the US declined by 55 or 3.87%. The previous week's decline was 61 rigs. This will limit production growth and may cause sustained declines in production which would help in balancing supply and demand in the market which would support price.
Below is the one-year chart of spot diesel futures prices as of January 23rd.
Below is the one-year chart of spot gasoline futures prices as of January 23rd.
: : Inventories increasing by 7.39 million barrels while inventories were expected to increase by 4.80 million barrels on the week. The five-year average inventory increased by 1.55 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.
: : The China HSBC flash manufacturing purchasing managers' index rose unexpectedly showing some strength in the manufacturing sector in China. This is supportive of petroleum demand expectations and price.
: : Eurozone January Markit manufacturing purchasing managers' index also rose unexpectedly indicating some relative strength in the European economy which is positive for petroleum demand expectations and price.
: : Stock market increasing by +1.60% on the week is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increasing sharply by 2.42% 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 23rd.
Below is the one-year chart for the US dollar index as of January 23rd.
During the week ended January 16th, total petroleum inventories increased by 7.39 million barrels vs. a five year average increase of 1.55 million barrels and vs. an expected increase of 4.80 million barrels. Inventories increased by 5.84 million barrels vs. the five year average. Total inventories stand at 775.4 million barrels, up from 768.0 million barrels at the end of the previous week. The five year average inventory is 718.8 million barrels, up from 717.2 million barrels at the end of the previous week.
Current inventories are 7.87% higher than the five year average, up from +7.07% 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 20th, the net speculative long position in petroleum futures was 226,179,000 barrels down 5,385,000 barrels (-2.51%) from the previous week. Speculation decreased for the first time in three weeks and represents 29.17% of domestic inventories. Speculation is 25.23% below its one year moving average. The corresponding spot month diesel futures price on January 20th was 162.66 cents per gallon, down 0.64 cents from 163.30 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 62.77% 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 39.40% 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 196.70 cents per gallon or 34.14 cents per gallon more than current prices. The analysis would indicate that about negative 20.90% 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 unchanged 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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