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Prices Up - Speculation Up - US Production Down - Inventory Down
During the week ending February 26th, the spot month diesel futures price increased by 2.57 cents per gallon (+2.51%) while the deferred months increased by 1 to 3 cent per gallon making the forward pricing curve higher and less positively sloped. The one year forward price ended the week at a 23.07 cent premium to the spot price, from a premium of 22.94 cents at the end of the previous week.
The change in level and slope of the diesel forward pricing curve indicates higher demand expectations and lower inventories 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 February 26th, the spot month gasoline futures price increased by 5.72 cents per gallon (+5.96%) while the deferred months increased by 2 to 9 cents per gallon making the forward pricing curve higher and less positively sloped. The one year forward price ended the week at a 13.41 cent premium to the spot price, from a premium of 13.94 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. Supply includes speculation which was higher on the week.
The US dollar was higher on the week which is negative for price. Inventories on the week were lower and lower than expected which is positive for price. The stock market, as a proxy for demand expectations, was higher which is positive for price. Speculation was higher on the week which is positive for price. US domestic crude production was lower which is positive for price. Domestic production has gone negative on a year over year basis which means that the slow decline in domestic production is most likely underway.
Weekly US petroleum demand increased by 4.69% during the week ending February 19th. Domestic demand is up 0.17% vs. one-year ago and demand is currently 3.89% above the five year average.
Domestic production decreased for the sixth week in a row and is 1.97% below one year ago levels. The number of operating oil drilling rigs in the US decreased for the 10th week in a row by 13 rigs to 400. This is more than a 75% decline from the maximum of 1609 in October 2014. This is the lowest level since December 2009. A lower rig count is positive for price. The lower rig count is expected to cause US production to move downward as part of the global rebalancing of supply and demand. It is expected that US crude production will decrease by 500,000 barrels per day during 2016.
Below is the one-year chart of spot diesel futures prices as of February 26th.
Below is the one-year chart of spot gasoline futures prices as of February 26th.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased by 0.39 million barrels while inventories were expected to increase by 1.02 million barrels on the week. The five-year average inventory decreased by 0.84 million barrels. Inventories increased vs. the five year average and decreased vs. expectations.
: : Storage capacity is nearing its limit especially in Cushing, Oklahoma which is the delivery point for the West Texas Intermediate Crude oil futures traded in New York. If capacity were to be reached, production may necessarily need to be slowed or stopped because there would be nowhere to go with the oil.
: : The surplus in oil is expected to be larger than thought during the first half of 2016. More supply from Iran and Iraq than expected, and slowing global demand growth are the contributing factors. The global imbalance is expected to increase to 1.75 million barrels per day from 1.50.
: : American producers may be going bankrupt earlier than thought due to the very low prices which curtails their revenues, and the fact that hedges are rolling off leaving producers exposed to low prices. As this occurs, production may be shut in thus curtailing supply which will contribute to the rebalance of the market.
: : Iran and Saudi Arabia appear to be unwilling to cut production or participate in a "freeze" of production which wouldn't do much to ease global oversupply anyway. More production for a longer period of time is the forecast and of course this is negative for price and keeps prices low.
: : Defaults and bankruptcies seen as increasing as lower prices increase the stress on domestic producers. This will cut investment in drilling and exploration and eventually production which will help balance supply and demand.
: : Stock market increasing by +1.58% on the week is generally positive for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by 1.60% 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.
The chart below shows supply and demand history and expectations. When supply and demand begin to rebalance, prices will increase from current levels. This forecast indicates that the market will be slower to balance than was thought in January.
Below is the one-year chart US stock market prices as of February 26th.
Below is the one-year chart for the US dollar index as of February 26th.
During the week ended February 19th, total petroleum inventories decreased by 0.39 million barrels vs. a five year average decrease of 0.84 million barrels and vs. an expected increase of 1.02 million barrels. Inventories increased by 0.44 million barrels vs. the five year average and decreased by 1.42 million barrels vs. expectations. Total inventories stand at 924.8 million barrels, down from 925.2 million barrels at the end of the previous week. The five year average inventory is 738.3 million barrels, down from 739.1 million barrels at the end of the previous week.
Current inventories are 25.26% higher than the five year average, up from +25.17% at the end of the previous week.
As of February 23rd, the net speculative long position in petroleum futures was 108,097,000 barrels, up 6,430,000 barrels (+6.32%) from the previous week. Speculation increased for the first time in two weeks and represents 11.69% of domestic inventories. Speculation is 27.91% below its one year moving average. The corresponding spot month diesel futures price on February 23rd was 102.21 cents per gallon, down 0.49 cents from 102.70 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 81.73% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 66.80% of diesel fuel price movements are explained by changes in level of speculation. With the current over supply situation and the expectation that this will persist, long-side speculation should remain relatively low.
The net speculative long position has been variable over the past year ranging between 57 million and 285 million barrels with an average of about 150 million barrels, which is down about 2 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 26th, the market price for spot month diesel futures is estimated to be 104.48 versus the actual price of 105.12. This indicates that the market is currently undervalued by 0.64 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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