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Prices Lower - Speculation Higher - US Production Down - Inventory Down
In the wake of the U.K. voting to leave the EU, the Pound Sterling sharply declined and the dollar became stronger. This coupled with economic uncertainty and expectation of lower economic growth rates caused by "Brexit", petroleum prices declined sharply on Friday along with the stock market.
During the week ending June 24th, the spot month diesel futures price decreased by 2.64 cents per gallon (-1.78%) while the deferred months decreased by 0 to 2 cent per gallon making the forward pricing curve slightly lower and slightly more positively sloped. The one year forward price ended the week at a 10.93 cent premium to the spot price, from a premium of 8.81 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 inventories with respect to demand. Demand includes speculative demand which increased 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 June 24th, the spot month gasoline futures price increased by 1.97 cents per gallon (+1.31%) while the deferred months changed by +2 to -2 cents per gallon making the forward pricing curve about unchanged in level but less positively sloped. The one year forward price ended the week at an 8.20 cent premium to the spot price, from a premium of 11.00 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates steady demand expectations and lower inventory levels with respect to supply and demand. Supply includes speculation which was higher on the week.
The US dollar was sharply higher in the wake of "Brexit" 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 lower which is negative for price. Speculation was higher on the week which is positive for price. US domestic crude production was lower which is positive for price. Domestic production is down 9.65% on a year over year basis.
Weekly US petroleum demand decreased by 3.98% during the week ending June 17th. Domestic demand is up 2.11% vs. one-year ago and demand is currently 5.95% above the five year average.
Domestic production continued its decline this week and is 9.65% below one year ago levels. The number of operating oil drilling rigs in the US continued to fall and stands at 330 which is 7 fewer than the previous week and 79.49% lower than the peak in October 2014. A higher rig count is negative for price. The generally lower rig count is causing US production to move downward as part of the global rebalancing of supply and demand. It is expected that US crude production will decrease to around 8.5 million barrels per day by year end. US domestic production has decreased by 542,000 barrels per day since the beginning of the year and 933,000 barrels per day since the peak in June 2015.
Below is the one-year chart of spot diesel futures prices as of June 24th.
Below is the one-year chart of spot gasoline futures prices as of June 24th.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased by 0.14 million barrels while inventories were expected to decrease by 1.48 million barrels on the week. The five-year average inventory increased by 0.11 million barrels. Inventories decreased vs. the five year average and increased versus expectations.
: : Supply disruption due to wildfires in Canada is fading and has all but disappeared. This production coming back on-line is positive for global oil production and negative for price.
: : Nigerian production decreased to a 20 year low as militant attacks of oil facilities have disrupted supply. The timeframe in which this production returns to the market is uncertain. This situation is negative for supply and supportive of price.
: : The UK voting to exit the European Union sent shockwaves around the world's financial and commodity markets. In the short-term, the Pound Sterling has become weaker, the US Dollar stronger which exerts downward pressure on the prices of commodities priced in Dollars such as crude oil. Longer term, there is an expectation that a European Union without the UK will be negative for global GDP growth rates which is generally negative for petroleum demand expectations and price. Should additional countries exit the EU, the situation would be compounded.
: : The Stock market decreasing by 1.63% which is negative for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by +1.32% 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.
The charts below show supply and demand history and expectations in May and June. Supply and demand have begun to rebalance which is the main cause of increasing prices. The May and June forecasts are roughly the same regarding the time frame in which the market will rebalance.
Below is the one-year chart US stock market prices as of June 24th.
Below is the one-year chart for the US dollar index as of June 24th.
During the week ended June 17th, total petroleum inventories decreased by 0.14 million barrels vs. a five year average increase of 0.11 million barrels and vs. an expected decrease of 1.48 million barrels. Inventories decreased by 0.25 million barrels vs. the five year average and increased by 1.34 million barrels vs. expectations. Total inventories stand at 920.6 million barrels, down from 920.7 million barrels at the end of the previous week. The five year average inventory is 741.8 million barrels, up from 741.7 million barrels at the end of the previous week.
Current inventories are 24.10% higher than the five year average, down from +24.14% at the end of the previous week.
As of June 21st, the net speculative long position in petroleum futures was 236,615,000 barrels, up 25,342,000 barrels (+11.99%) from the previous week. Speculation increased for the first time in five weeks and represents 25.70% of domestic inventories. Speculation is 55.74% above its one year moving average. The corresponding spot month diesel futures price on June 21st was 151.67 cents per gallon, up 1.47 cents from 150.20 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 22.82% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 5.20% of diesel fuel price movements are explained by changes in level of speculation.
The net speculative long position has been variable over the past year ranging between 57 million and 277 million barrels with an average of about 152 million barrels, which is down about 1 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 June 21st, the market price for spot month diesel futures is estimated to be 147.90 versus the actual price of 151.67. This indicates that the market is currently overvalued by 3.77 cents per gallon given the assumptions of the pricing model.
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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