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Petroleum Market Commentary - May 25, 2015

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Prices Lower - Inventory Lower - Rig Count Lower - Dollar Up - Spec Down

DIESEL:

During the week ending May 22nd, the spot month diesel futures price decreased by 5.23 cents per gallon (-2.61%) while the deferred months decreased by 3 to 5 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 7.06 cent premium to the spot price, from a premium of 5.99 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.

GASOLINE:

During the week ending May 22nd, the spot month gasoline futures price decreased by 0.29 cents per gallon (-0.14%) while the deferred months decreased from 1 to 5 cents per gallon making the forward pricing curve lower and more negatively sloped. The one year forward price ended the week at an 8.90 cent discount to the spot price, from a discount of 6.29 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.

ANALYSIS:

The US dollar increased sharply on the week which is negative for price. Inventories on the week were lower which is positive for price. The stock market, as a proxy for demand expectations, was higher which is positive for price. Speculation was lower on the week which is negative for price. US domestic crude production was lower on the week which is positive for price. Domestic production is up 9.82% year over year, the lowest year over year increase since September 2012. This may be an indication that production growth rate may be slowing.

The attractiveness of making new hedges increased due to lower prices and lower speculation. On a flat-price basis, prices remain relatively attractive when compared to the last four years and are above the middle of where prices have been over the past four months. The market has found a price range. Speculation was lower giving the hedger 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.

DEMAND:

Weekly US petroleum demand decreased by 2.01% during the week ending May 15th. Domestic demand is up 3.90% vs. one-year ago and demand is currently 3.68% over the five year average.

PRODUCTION:

Domestic production decreased on the week. The number of operating oil drilling rigs in the US continues to decline. During the week, the number of operating rigs in the US declined by 1 or 0.15%. The previous week's decline was 8 rigs. This will limit production growth and is beginning to show stabilization and decline in production which is helping to balance supply and demand in the market which would support price. 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.

With US domestic production and US domestic inventories decreasing outright and not just a slowing in the rate of growth, prices are supported.

Many new wells are being drilled but not yet finished, fracked, and put into production. When prices rise, these wells could be put into production relatively quickly in response to higher prices and higher demand. This "fracklog" as it has been dubbed, will act as inventory being stored in the ground and will serve as a cap on prices in the short to medium-term. The question is at what price this will be triggered.





Below is the one-year chart of spot diesel futures prices as of May 22nd.



Below is the one-year chart of spot gasoline futures prices as of May 22nd.

MARKET FACTORS:

: :  Inventories continue to decrease from the recent high levels set on April 24th. Inventories decreased by 5.99 million barrels while inventories were expected to decrease by 0.41 million barrels on the week. The five-year average inventory increased by 0.08 million barrels. Inventories decreased vs. the five year average and vs. expectations. While inventories are large, we are seeing the first signs of market balancing with the overall reduction of inventory for the first time in six months. This slowing or stopping inventories from growing further will support price. However, the overall level of inventories will keep prices relatively low in the short to medium-term. The global market continues to be oversupplied by 1.5 to 2.0 million barrels per day.

: :  Stock market increasing by +0.16% on the week is positive for economic and petroleum demand expectations and prices.

: :  The US Dollar increasing by +3.09% 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 May 22nd.



Below is the one-year chart for the US dollar index as of May 22nd.



INVENTORIES:

During the week ended May 15th, total petroleum inventories decreased by 5.99 million barrels vs. a five year average increase of 0.08 million barrels and vs. an expected decrease of 0.41 million barrels. Inventories decreased by 6.07 million barrels vs. the five year average. Total inventories stand at 833.8 million barrels, down from 839.8 million barrels at the end of the previous week. The five year average inventory is 723.8 million barrels, up from 723.7 million barrels at the end of the previous week.

Current inventories are 16.04% higher than the five year average, down from +15.20% at the end of the previous week.



SPECULATION:

As of May 19th, the net speculative long position in petroleum futures was 263,176,000 barrels, down 15,268,000 barrels (-5.48%) from the previous week. Speculation has decreased for the second week and represents 31.58% of domestic inventories. Speculation is 7.52% above its one year moving average. The corresponding spot month diesel futures price on May 19th was 192.92 cents per gallon, down 6.97 cents from 199.89 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 47.21% correlated over the past 52 weeks indicating that, on a statistical basis over the past year 22.23% 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 165.88 cents per gallon or 27.04 cents per gallon less than current prices. The analysis would indicate that about 14.02% of current price is attributable to speculation and its underlying market rationale. This "would be" price was higher by slightly more than 1 cent on the week.

The net speculative long position has been variable over the past year ranging between 135 million and 453 million barrels with an average of about 245 million barrels, which is down about 3 million barrels on the week.

CONTACT:

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.