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Prices Lower - Inventory Higher - Rig Count Lower - Dollar Higher
During the week ending March 6th, the spot month diesel futures price decreased by 10.47 cents per gallon (-5.30%) while the deferred months decreased by 7 to 9 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at an 8.37 cent premium to the spot price, from a premium of 5.58 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 higher 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 March 6th, the spot month gasoline futures price decreased by 9.60 cents per gallon (-4.85%) while the deferred months decreased by 7 to 9 cents per gallon making the forward pricing curve lower and slightly negatively in sloped. The one year forward price ended the week at a 0.53 cent discount to the spot price, from a discount of 2.29 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and lower 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 lower which is negative for price. Speculation was lower on the week which is negative for price. US domestic crude production was higher on the week which is negative for price. Domestic production is up 15.44% year over year.
The attractiveness of making new hedges increased as prices were lower. From a flat-price basis, prices remain very attractive when compared to the last four years. The market has found a price range. Production is expected to continue to outstrip demand and inventories will continue to grow. There is a fear that land-based storage tanks will fill leaving more expensive alternatives which may drive down spot prices. Speculation was lower giving less competition with speculators for long positions. 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 decreased by 0.62% during the week ending February 27th. Domestic demand is up 7.654% vs. one-year ago and demand is currently 6.20% over the five year average.
Domestic production increased again to a new all-time high on the week. The number of operating oil drilling rigs in the US continues to decline and the decline is decelerating. During the week, the number of operating rigs in the US declined by 64 or 6.49%. The previous week's decline was 33 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. This will happen in the medium-term not the short-term. The market has been watching this metric very closely and the sharp downturn in the number of operating rigs has contributed to the recent price increase. While this is true, production continues to increase and inventories continue to grow. The market is taking the steps to balance the supply and demand yet increasing production and growing inventories will keep prices low.
Below is the one-year chart of spot diesel futures prices as of March 6th.
Below is the one-year chart of spot gasoline futures prices as of March 6th.
: : Inventories increasing by 8.63 million barrels while inventories were expected to decrease by 0.63 million barrels on the week. The five-year average inventory decreased by 2.32 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : The market continues to be oversupplied by about 1.5 to 2 million barrels per day. Balancing of supply and demand may take many months and 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. There is the very real possibility that crude oil land-based storage in the US reaches capacity and that spot prices would plummet.
: : China reduced its 2015 GDP forecasted growth rate to 7%. The Chinese economy grew at 7.5% in 2014. This decrease in the Chinese economic growth rate decreases the demand growth expectations for petroleum and is negative for price.
: : Libyan Islamic militants attacked oil facilities in that country forcing production to be disrupted. This disruption should be short-lived and have only a minor impact on the global supply picture. The incident was nevertheless supportive of price.
: : The European Central Bank raised the Eurozone GDP growth rate forecast for 2015 from 1.0% to 1.5%. This is supportive of petroleum demand expectations and price.
: : Stock market decreasing by -1.58% on the week is negative for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by 2.44% 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 March 6th.
Below is the one-year chart for the US dollar index as of March 6th.
During the week ended February 27th, total petroleum inventories increased by 8.63 million barrels vs. a five year average decrease of 2.32 million barrels and vs. an expected decrease of 0.63 million barrels. Inventories increased by 10.94 million barrels vs. the five year average. Total inventories stand at 807.4 million barrels, up from 798.8 million barrels at the end of the previous week. The five year average inventory is 721.3 million barrels, down from 723.6 million barrels at the end of the previous week.
Current inventories are 11.94% higher than the five year average, up from +10.39% 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 March 3rd, the net speculative long position in petroleum futures was 195,538,000 barrels down 33,031,000 barrels (-14.45%) from the previous week. Speculation decreased for the second week in a row and represents 24.22% of domestic inventories. Speculation is 31.25% below its one year moving average. The corresponding spot month diesel futures price on March 6th was 193.95 cents per gallon, down 8.94 cents from 202.89 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 60.22% correlated over the past 52 weeks indicating that, on a statistical basis over the past year 36.27% 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 179.8 cents per gallon or 14.15 cents per gallon less than current prices. The analysis would indicate that about negative 7.72% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 2 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 284 million barrels, which is down about 4 million barrels 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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