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Geopolitical Risk - Prices Higher - Dollar Lower - Speculation Lower - Inventory Higher - Production Higher - Rig Count Higher
During the week ending April 13th, the spot month diesel futures price increased by 14.24 cents per gallon (+7.27%) while the deferred months decreased by 3 to 14 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at an 8.51 cent discount to the spot price, from a discount 3.61 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 April 13th, the spot month gasoline futures price increased by 11.07 cents per gallon (+5.66%) while the deferred months increased by 3 to 11 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 7.64 cent discount to the spot price, from a discount of 5.08 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 decreased by 6.62% during the week ending April 6th. Domestic demand is up by 4.97% vs. one-year ago and demand is currently 8.26% above the five year average.
Domestic production increased on the week and is 13.97% above year ago levels. The number of operating oil drilling rigs in the US was higher by 7 to 815. Currently, this is 499 more than the recent low of 316 in 2016 and 49.35% 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 2,097,000 barrels per day (+24.88%) since the low on July 1, 2016. For perspective, OPEC production cuts in place since November 2016 is 1.8 million barrels per day – less than the amount that US domestic production has grown during that time.
Below is the one-year chart of spot diesel futures prices as of April 13th.
Below is the one-year chart of spot gasoline futures prices as of April 13th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories increased on the week by 2.72 million barrels while inventories were expected to decrease by 1.98 million barrels on the week. The five-year average inventory increased by 1.19 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : Worries that the US and China will be having an all-out trade war eased on the week due to remarks by the Chinese President. This decreases the likelihood of lower economic growth from a trade war which is positive for petroleum demand expectations and price.
: : Geopolitical risk flared during the week with the impending attack on Syria that occurred on Friday evening. The expectation that the Syrian situation will most likely not escalate causes the likelihood of supply disruption to be lower which is negative for price. Also, Yemen launched several missiles into Saudi Arabia which caused a jump in price due to geopolitical risk.
: : OPEC is continuing to talk about keeping the supply cuts longer than expected into 2019. The non-OPEC members of the coalition are indicating that cooperation with OPEC may be a permanent arrangement. This is supportive of price. As OPEC and Friends keeps their output cuts in place, US shale production will continue to grow to meet global demand growth. This will diminish OPEC’s market share. Will this play out like it did in 2014? Will OPEC eventually want market share back? Time will tell the results of the Shale vs. OPEC battle.
: : The Stock market increased by +1.99% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreased by -0.34% on the week is positive 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 – Down 170,000 barrels per day from February to March.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of April 2018. According to the chart, global supply has been about 500,000 barrels per day less than consumption for the past year which has caused global inventories to decrease to near five year average levels. The surplus expected for the remainder of 2018 and 2019 has decreased slightly since the March forecast. An expected surplus moving forward is negative for price but the slow tightening of the oil market is positive for price.
Below is the one-year chart US stock market prices as of April 13th.
Below is the one-year chart for the US dollar index as of April 13th.
During the week ended April 6th, total petroleum inventories increased by 2.72 million barrels vs. a five year average increase of 1.19 million barrels and vs. an expected decrease of 1.98 million barrels. Inventories increased by 1.53 million barrels vs. the five year average and increased by 4.70 million barrels vs. expectations. Total inventories stand at 796.0 million barrels, up from 793.3 million barrels at the end of the previous week. The five year average inventory is 803.2 million barrels, up from 802.1 million barrels at the end of the previous week.
Current inventories are 0.90% lower than the five year average, up from -1.09% at the end of the previous week. Inventory remains below the five year average for the third week.
As of April 10th, the net speculative long position in petroleum futures was 555,801,000 barrels, down 12,194,000 barrels (-2.15%) from the previous week. Speculation decreased for the second week and represents 69.82% of domestic inventories. Speculation is 37.60% above its one year moving average. The corresponding spot month diesel futures price on April 10th was 206.48 cents per gallon, up 6.98 cents from 199.50 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 94.49% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 89.28% 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 404 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 April 10th, the market price for spot month diesel futures is estimated to be 228.06 versus the actual price of 206.48. This indicates that the market is currently undervalued by 21.58 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 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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