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Speculation Gone Wild - Dollar Plunges - Prices Higher - Record Production - Hedging Gone Wild
During the week ending January 26th, the spot month diesel futures price increased by 7.76 cents per gallon (+3.77%) while the deferred months increased by 1-7 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 10.64 cent discount to the spot price, from a discount of 6.47 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates higher demand expectations and lower inventories with respect to demand. Demand also includes speculation which was sharply 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 26th, the spot month gasoline futures price increased by 7.41 cents per gallon (+3.98%) while the deferred months changed by -1 to +3 cents per gallon making the forward pricing curve generally higher and more negatively sloped. The one year forward price ended the week at a 15.61 cent discount to the spot price, from a discount of 11.68 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. Demand also includes speculation which was sharply higher on the week.
Weekly US petroleum demand decreased by 0.83% during the week ending January 19th. Domestic demand is up by 8.12% vs. one-year ago and demand is currently 5.12% above the five year average.
Domestic production increased on the week and is 10.23% above year ago levels. The number of operating oil drilling rigs in the US was higher by 12 to 759 which is 9 lower than the recent high of 768. Currently, this is 443 more than the recent low of 316 in 2016 and 53.83% lower than the peak of 1609 in October 2014. The relatively high rig count is causing US production to grow as the global rebalancing of supply and demand and the return of global inventories to normal levels continues. US domestic production has increased by 1,450,000 barrels per day (+17.20%) since the low on July 1, 2016.
Below is the one-year chart of spot diesel futures prices as of January 26th.
Below is the one-year chart of spot gasoline futures prices as of January 26th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories increased on the week by 2.67 million barrels while inventories were expected to increase by 0.57 million barrels on the week. The five-year average inventory increased by 4.72 million barrels. Inventories decreased vs. the five year average and increased vs. expectations. Petroleum inventories including crude, gasoline, and distillate have been relatively steady for the past three months.
: : As was true previously, prices continue to increase and speculation increases to new highs yet again, the amount of oil being produced and hedged by producers is also at all-time highs. As measured by short positions of swap dealers (a good proxy for producer hedging) producer hedging is now at 925 million barrels and net long speculation is at 702 million barrels. Since the end of June, speculation has risen by 621 million barrels and short hedging has risen by 499 million barrels. It appears that speculators have been buying from producer hedgers all else being equal. When hedgers begin to make good on those hedges and start delivering significantly more barrels, prices will correct quickly. Speculators will sell their positions. Unlike during the recent price rise, producers will not be buying back their positions should prices decrease. This will leave an enormous amount of speculation to be sold to some other buyers on the way down at lower prices. Long hedgers will allow them to exit the market but not at current market prices.
: : OPEC and friends are now discussing acting as a cartel beyond the end of the current supply quotas. This will cause a re-run of the movie we saw from 2010 to 2014: more US production, OPEC loss of market share, etc. While OPEC likes current pricing, they realize that price is too high currently and is attracting more US production.
: : The sharply lower dollar is the main factor for higher prices on the week.
: : The Stock market increased by +2.23% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreased by -1.66% on the week is positive 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.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of January 2018. According to the chart, global supply and demand have essentially rebalanced and there was a deficit of about 0.5 million barrels per day in 2017. Moving forward into 2018 and 2019, balance or a slight surplus is expected. The 2017 deficit has been supportive of price. Balance to slight surplus moving forward is neutral to negative for price.
Below is the one-year chart US stock market prices as of January 26th.
Below is the one-year chart for the US dollar index as of January 26th.
During the week ended January 19th, total petroleum inventories increased by 2.67 million barrels vs. a five year average increase of 4.72 million barrels and vs. an expected increase of 0.57 million barrels. Inventories decreased by 2.05 million barrels vs. the five year average and increased by 2.10 million barrels vs. expectations. Total inventories stand at 795.5 million barrels, up from 792.8 million barrels at the end of the previous week. The five year average inventory is 781.7 million barrels, up from 776.9 million barrels at the end of the previous week.
Current inventories are 1.77% higher than the five year average, down from +2.04% at the end of the previous week.
As of January 23rd, the net speculative long position in petroleum futures was 702,242,000 barrels, up 29,552,000 barrels (+4.39%) from the previous week. Speculation increased for the third week again to a new all-time high and represents an unprecedented 88.28% of domestic inventories. Speculation is 93.95% above its one year moving average. The corresponding spot month diesel futures price on January 23rd was 208.61 cents per gallon, up 2.27 cents from 206.34 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 85.96% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 73.90% of diesel fuel price movements are explained by changes in level of speculation.
The net speculative long position has been variable over the past year ranging between 81 million and 703 million barrels with an average of about 362 million barrels, which is up roughly 4 million barrels on the week.
Based on a multiple regression analysis considering the level of the dollar, speculation, and inventory over the past five years as of January 23rd, the market price for spot month diesel futures is estimated to be 257.91 versus the actual price of 208.61. This indicates that the market is currently undervalued by 49.30 cents per gallon given the assumptions of the pricing model.
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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