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Prices Higher - Dollar Higher - Speculation Lower - Production Higher - Higher Rig Count
During the week ending March 16th, the spot month diesel futures price increased by 2.52 cents per gallon (+1.34%) while the deferred months increased by 0 to 3 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 0.16 cent discount to the spot price, from a premium of 0.66 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 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 16th, the spot month gasoline futures price increased by 4.16 cents per gallon (+2.18%) while the deferred months increased by 1 to 4 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 5.54 cent discount to the spot price, from a discount of 3.41 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 lower on the week.
Weekly US petroleum demand increased by 2.25% during the week ending March 9th. Domestic demand is up by 3.16% vs. one-year ago and demand is currently 7.58% above the five year average.
Weekly production remains above 10 million barrels per day.
Domestic production increased on the week and is 13.96% above year ago levels. The number of operating oil drilling rigs in the US was higher by 4 to 800. Currently, this is 484 more than the recent low of 316 in 2016 and 50.28% lower than the peak of 1609 in October 2014. This 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 1,953,000 barrels per day (+23.17%) since the low on July 1, 2016. For perspective, OPEC production cuts in place since November 2016 is 1.8 million barrels per day – roughly 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 March 16th.
Below is the one-year chart of spot gasoline futures prices as of March 16th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories decreased on the week by 5.61 million barrels while inventories were expected to decrease by 0.22 million barrels on the week. The five-year average inventory decreased by 0.95 million barrels. Inventories decreased vs. the five year average and increased vs. expectations.
: : The likelihood that the Iran nuclear deal will be revised which may bring back sanctions on Iran including curtailing their oil exports has resulted is a boost in geopolitical risk as sanction-era Iranian production was 1 million barrels per day lower than current production. Taking 1 million barrels per day off of the global market would cause a deficit that may or may not be made up by Saudi Arabia and other producers. The removal of the Iran nuclear deal would be positive for price.
: : OPEC is now at 147% compliance with its 1.8 million barrels per day limiting of supply (2.65 million barrels per day) due to compliance from OPEC members and due to the collapse of Venezuelan production cause by the political/economic turmoil there. Venezuelan production has decreased by 290,000 barrels per day since September to 1.68 million barrels per day. This downward trend is likely to continue. This curtails supply and is supportive of price.
: : The Stock market decreased by +1.24% which is negative for economic and petroleum demand expectations and prices.
: : The US Dollar increased by +0.16% 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 March 2018. According to the chart, global supply and demand have essentially rebalanced. Starting in Q2 2018, there is an expectation of a surplus which is negative for price.
Below is the one-year chart US stock market prices as of March 16th.
Below is the one-year chart for the US dollar index as of March 16th.
During the week ended March 9th, total petroleum inventories decreased by 5.61 million barrels vs. a five year average decrease of 0.95 million barrels and vs. an expected decrease of 0.22 million barrels. Inventories decreased by 4.66 million barrels vs. the five year average and decreased by 5.39 million barrels vs. expectations. Total inventories stand at 808.8 million barrels, down from 814.4 million barrels at the end of the previous week. The five year average inventory is 799.1 million barrels, down from 800.0 million barrels at the end of the previous week.
Current inventories are 1.21% higher than the five year average, down from +1.79% at the end of the previous week.
As of March 13th, the net speculative long position in petroleum futures was 543,113,000 barrels, down 22,406,000 barrels (-3.96%) from the previous week. Speculation decreased for the second week and represents 67.15% of domestic inventories. Speculation is 41.59% above its one year moving average. The corresponding spot month diesel futures price on March 13th was 187.39 cents per gallon, down 2.94 cents from 190.33 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 93.58% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 87.57% of diesel fuel price movements are explained by changes in level of speculation. Higher levels of speculation typically cause higher correlation.
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 384 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 March 13th, the market price for spot month diesel futures is estimated to be 231.33 versus the actual price of 187.39. This indicates that the market is currently undervalued by 43.94 cents per gallon given the assumptions of the pricing model. Producer hedging appears to be keeping prices lower than they would ordinarily be.
Five Year History of Producer Hedging
Producer hedging and speculation have each grown by 400-600 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.
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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