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Petroleum Market Commentary - February 12, 2018

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Prices Sharply Lower - Dollar Higher - Speculation Down - Surging Production - Sharply Higher Rig Count

DIESEL:

During the week ending February 9th, the spot month diesel futures price decreased by 19.84 cents per gallon (-9.66%) while the deferred months decreased by 9-19 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 2.11 cent discount to the spot price, from a discount of 7.60 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 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.

GASOLINE:

During the week ending February 9th, the spot month gasoline futures price decreased by 17.18 cents per gallon (-9.18%) while the deferred months decreased by 10-17 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 7.91 cent discount to the spot price, from a discount of 11.43 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 lower on the week.

ANALYSIS:

DEMAND:

Weekly US petroleum demand decreased by 0.76% during the week ending February 2nd. Domestic demand is up by 4.82% vs. one-year ago and demand is currently 8.87% above the five year average.

PRODUCTION:

Weekly production exceeds 10 million barrels per day.

Domestic production increased on the week and is 14.18% above year ago levels. The number of operating oil drilling rigs in the US was higher by 26 to 791 which is 3 lower than the recent high of 768. Currently, this is 475 more than the recent low of 316 in 2016 and 50.84% lower than the peak of 1609 in October 2014. The 33-month 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 1,823,000 barrels per day (+21.63%) since the low on July 1, 2016. For perspective, OPEC production cuts in place since November 2016 is 1.8 million barrels per day – the same amount that US domestic production has grown during that time.









Below is the one-year chart of spot diesel futures prices as of February 9th.



Below is the one-year chart of spot gasoline futures prices as of February 9th.

MARKET FACTORS & COMMENTARY:

: :  Petroleum inventories increased on the week by 9.24 million barrels while inventories were expected to increase by 1.87 million barrels on the week. The five-year average inventory increased by 2.89 million barrels. Inventories increased vs. the five year average and increased vs. expectations. Petroleum inventories including crude, gasoline, increased to a 15-week high and exceeded 800 million barrels for the first time since October 20th.

: :  Production surged to new all-time highs in the US as more shale production is coming on line and more rigs are currently drilling oil wells. The market recognizes that this surge in production will remain and that higher inventories for the next two years would be expected. Global supply is expected to increase by 2.45 million barrels per day in 2018.

: :  While global inventories decreased by 500,000 barrels per day in 2017, expectations are that inventories will increase by 200,000 barrels per day in 2018 and 2019 which would return global inventories to early 2017 levels by the end of 2019.

: :  The Stock market decreased by -5.15% which is negative for economic and petroleum demand expectations and prices. Equity market volatility and selling appeared to have affected petroleum markets driving prices lower.

: :  The US Dollar increased by +1.40% 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 February 2018. According to the chart, global supply and demand have essentially rebalanced. Starting in Q2 2018, there is an expectation of a slight surplus which is negative for price.

FEBRUARY FORECAST



Below is the one-year chart US stock market prices as of February 9th.



Below is the one-year chart for the US dollar index as of February 9th.



INVENTORIES:

During the week ended February 2nd, total petroleum inventories increased by 9.24 million barrels vs. a five year average increase of 2.89 million barrels and vs. an expected increase of 1.87 million barrels. Inventories increased by 6.34 million barrels vs. the five year average and increased by 7.37 million barrels vs. expectations. Total inventories stand at 807.6 million barrels, up from 798.3 million barrels at the end of the previous week. The five year average inventory is 791.9 million barrels, up from 789.0 million barrels at the end of the previous week.

Current inventories are 1.97% higher than the five year average, up from +1.18% at the end of the previous week.



SPECULATION:

As of February 6th, the net speculative long position in petroleum futures was 664,301,000 barrels, down 38,000,000 barrels (-5.41%) from the previous week. Speculation decreased for the first time in five weeks and represents 82.26% of domestic inventories. Speculation is 79.14% above its one year moving average. The corresponding spot month diesel futures price on February 6th was 198.51 cents per gallon, down 8.66 cents from 207.17 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 89.09% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 79.38% 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 371 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 February 6th, the market price for spot month diesel futures is estimated to be 241.60 versus the actual price of 198.51. This indicates that the market is currently undervalued by 43.09 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 is causing a surge in production and lower prices.



CONTACT:

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.