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Prices Down - Dollar Higher - Speculation Steady - Higher Production - Higher Rig Count - Higher Producer Hedging
During the week ending February 2nd, the spot month diesel futures price decreased by 7.40 cents per gallon (-3.48%) while the deferred months decreased by 3-6 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 7.60 cent discount to the spot price, from a discount of 10.64 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates lower demand expectations and higher inventories with respect to demand. Demand also includes speculation which was steady 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 February 2nd, the spot month gasoline futures price decreased by 5.43 cents per gallon (-2.82%) while the deferred months decreased by 1-2 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at an 11.43 cent discount to the spot price, from a discount of 15.61 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. Demand also includes speculation which was steady on the week.
Weekly US petroleum demand increased by 1.78% during the week ending January 26th. Domestic demand is up by 7.55% vs. one-year ago and demand is currently 6.30% above the five year average.
Domestic production increased on the week and is 11.26% above year ago levels. The number of operating oil drilling rigs in the US was higher by 6 to 765 which is 3 lower than the recent high of 768. Currently, this is 449 more than the recent low of 316 in 2016 and 52.45% 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 1,491,000 barrels per day (+17.69%) since the low on July 1, 2016.
Below is the one-year chart of spot diesel futures prices as of February 2nd.
Below is the one-year chart of spot gasoline futures prices as of February 2nd.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories increased on the week by 2.86 million barrels while inventories were expected to increase by 1.96 million barrels on the week. The five-year average inventory increased by 7.38 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 between 790 and 800 million barrels.
: : OPEC production grew by 20,000 barrels per day and has remained very steady over the past nine months between 32.3 and 32.9 million barrels per day. During this same time, US production has grown by 600,000 barrels per day.
: : The Stock market decreased by -3.85% which is negative for economic and petroleum demand expectations and prices.
: : The US Dollar increased by +0.14% on the week 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.
OPEC Production Five Year History.
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 February 2nd.
Below is the one-year chart for the US dollar index as of February 2nd.
During the week ended January 26th, total petroleum inventories increased by 2.86 million barrels vs. a five year average increase of 7.38 million barrels and vs. an expected increase of 1.96 million barrels. Inventories decreased by 4.53 million barrels vs. the five year average and increased by 0.90 million barrels vs. expectations. Total inventories stand at 798.3 million barrels, up from 795.5 million barrels at the end of the previous week. The five year average inventory is 789.0 million barrels, up from 781.7 million barrels at the end of the previous week.
Current inventories are 1.18% higher than the five year average, down from +1.77% at the end of the previous week.
As of January 30th, the net speculative long position in petroleum futures was 702,301,000 barrels, up 59,000 barrels (+0.01%) from the previous week. Speculation increased for the fourth week to a new all-time high and represents 87.97% of domestic inventories. Speculation is 91.59% above its one year moving average. The corresponding spot month diesel futures price on January 30th was 207.17 cents per gallon, down 1.44 cents from 208.61 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 88.03% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 77.49% 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 367 million barrels, which is up roughly 5 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 30th, the market price for spot month diesel futures is estimated to be 262.67 versus the actual price of 207.17. This indicates that the market is currently undervalued by 55.50 cents per gallon given the assumptions of the pricing model. Producer hedging appears to be keeping prices lower than they would ordinarily be.
Three Year History of Producer Hedging
Producer hedging and speculation have each grown by 500-600 million barrels since June suggesting that speculators are buying from hedgers with an expectation that speculators will unwind their trade and hedgers will not and will deliver oil instead. This would cause a surge in production and lower prices.
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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