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Prices Lower - Inventory Up - Rig Count Down - Dollar Down - Spec Up
During the week ending April 3rd, the spot month diesel futures price decreased by 3.91 cents per gallon (-2.27%) while the deferred months decreased by 0 to 4 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 15.13 cent premium to the spot price, from a premium of 12.77 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 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 April 3rd, the spot month gasoline futures price decreased by 3.55 cents per gallon (-1.98%) while the deferred months decreased from 0 to 3 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 3.98 cent premium to the spot price, from a discount of 0.53 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.
The US dollar decreased on the week which is positive for price. Inventories on the week were higher which is negative 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 on the week which is positive for price. Domestic production is up 14.58% 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 and are near the middle of where prices have been over the past four months. The market has found a price range. Production is expected to continue to outstrip demand and inventories will continue to grow into the second half of 2015. There is a fear that land-based storage tanks will fill leaving more expensive alternatives which may drive down spot prices. Speculation was higher giving the hedger more 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 increased by 4.14% during the week ending March 27th. Domestic demand is up 2.74% vs. one-year ago and demand is currently 2.56% over the five year average.
Domestic production decreased slightly 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 11 or 1.35%. The previous week's decline was 12 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. As the rate of change in production and inventory growth decreases, the market will take this as a signal to buy and prices will firm up.
Below is the one-year chart of spot diesel futures prices as of April 3rd.
Below is the one-year chart of spot gasoline futures prices as of April 3rd.
: : Inventories increasing by 1.83 million barrels, the smallest increase in four months, while inventories were expected to increase by 3.31 million barrels on the week. The five-year average inventory increased by 1.28 million barrels. Inventories increased vs. the five year average and decreased vs. expectations - This was the first decrease vs. expectations in two months.
: : 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.
: : The speculative short position that grew for crude oil has decreased in size as speculators are not as confident that storage facilities will fill up and prices will decrease. This was supportive of price on the week since these short positions needed to buy back the positions in order to exit the trade.
: : Prices were supported as Saudi Arabia announced that it is raising prices for crude oil shipments to its Asian customers in May. Beside the fact that this is higher price, it indicates that demand may be stronger due to low price in Asia. This is directly positive for price and also indicates stronger demand which is also positive for price.
: : The Iranian nuclear treaty appears to be negotiated although there are many things that need to happen before it is complete. The treaty is one step closer to completion and Iran is one step closer to the end of economic sanctions. When this happens, Iran will be free to sell oil again which will increase global supply and will be negative for price. The market reacted to this later in the week as prices declined.
: : The rally in the stock market and the hope for additional economic stimulus from China supported global economic outlook and also global petroleum demand expectations and price.
: : US domestic crude production decreased slightly on the week. The market took this as perhaps an early sign of slowing the growth of or outright decreasing US production and the report was supportive of price. Lower US production or production growth would be an expectation given that the domestic rig count (the number of oil rigs operating in the US) has fallen by half since October although the rate of decline has slowed in the past several weeks.
: : Stock market increasing by +0.29% on the week is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreasing by -0.77% 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 April 3rd.
Below is the one-year chart for the US dollar index as of April 3rd.
During the week ended March 27th, total petroleum inventories increased by 1.83 million barrels vs. a five year average increase of 1.28 million barrels and vs. an expected increase of 3.31 million barrels. Inventories increased by 0.56 million barrels vs. the five year average. Total inventories stand at 827.7 million barrels, up from 825.9 million barrels at the end of the previous week. The five year average inventory is 720.6 million barrels, up from 719.4 million barrels at the end of the previous week.
Current inventories are 14.86% higher than the five year average, up from +14.81% 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 speculative 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.
The short speculation in crude futures that had increased last week has decreased. This means that the market is less positioned for a significant drop in price due to inventory growing to over capacity. Consequently,
As of March 31st, the net speculative long position in petroleum futures was 161,569,000 barrels up 25,883,000 barrels (+19.08%) from the previous week. Speculation increased for the first time in six weeks and represents 19.52% of domestic inventories. Speculation is 39.39% below its one year moving average. The corresponding spot month diesel futures price on March 31st was 171.79 cents per gallon, up 1.14 cents from 170.65 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 62.57% correlated over the past 52 weeks indicating that, on a statistical basis over the past year 39.14% 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 167.13 cents per gallon or 4.66 cents per gallon less than current prices. The analysis would indicate that about 2.73% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 3 cents lower on the week.
The net speculative long position hit a new 52 week low during the past week. It has been variable over the past year ranging between 135 million and 453 million barrels with an average of about 267 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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