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Prices Lower - Speculation Lower - US Production Up - Rig Count Up
During the week ending July 22nd, the spot month diesel futures price decreased by 4.04 cents per gallon (-2.89%) while the deferred months decreased by 3 to 5 cent per gallon making the forward pricing curve lower and virtually unchanged in slope. The one year forward price ended the week at a 15.37 cent premium to the spot price, from a premium of 16.12 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 steady inventories with respect to demand. Demand includes speculative demand which decreased 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 July 22nd, the spot month gasoline futures price decreased by 6.05 cents per gallon (-4.25%) while the deferred months decreased by 2 to 7 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 14.12 cent premium to the spot price, from a premium of 12.55 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. Demand includes speculative demand which was lower on the week.
The US dollar was higher 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 higher which is negative for price. Domestic production is down 11.13% on a year over year basis. Oil rig count indicating the number of oil wells currently being developed by drilling was higher on the week which is negative for price.
Weekly US petroleum demand increased by 6.20% during the week ending July 15th. Domestic demand is up 1.80% vs. one-year ago and demand is currently 4.50% above the five year average.
Domestic production increased for the second week after reaching a two year low level. Current production is 11.13% below year ago levels. The number of operating oil drilling rigs in the US increased for the fourth week in a row and the seventh time in nine weeks and stands at 371 which is 14 more than the previous week, 55 more than the recent low of 316 and 76.94% lower than the peak of 1609 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. US domestic production has decreased by 725,000 barrels per day since the beginning of the year and 1,116,000 barrels per day since the peak in June 2015.
Below is the one-year chart of spot diesel futures prices as of July 22nd.
Below is the one-year chart of spot gasoline futures prices as of July 22nd.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased by 1.66 million barrels while inventories were expected to decrease by 0.54 million barrels on the week. The five-year average inventory increased by 2.37 million barrels. Inventories decreased vs. the five year average and vs. expectations.
: : Producers have hedged production for 2017 locking in revenues and as protection against falling prices. This means that more production may be coming on-line in order to complete the hedges. More production would of course be negative for price. The uptick in domestic production and domestic rig count indicate that activity has picked up.
: : The coup in Turkey was a non-event with respect to the transportation of oil with little to no effect on price.
: : The end of the summer driving season is upon us and petroleum inventories are ample to keep up with demand. These inventories will need to shrink further thus diminishing the demand for new crude oil which is negative for price.
: : The Stock market increasing by 0.64% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by +0.92% 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 July 22nd.
Below is the one-year chart for the US dollar index as of July 22nd.
During the week ended July 15th, total petroleum inventories decreased by 1.66 million barrels vs. a five year average increase of 2.37 million barrels and vs. an expected decrease of 0.54 million barrels. Inventories decreased by 4.01 million barrels vs. the five year average and decreased by 1.10 million barrels vs. expectations. Total inventories stand at 913.2 million barrels, down from 914.9 million barrels at the end of the previous week. The five year average inventory is 736.9 million barrels, up from 734.6 million barrels at the end of the previous week.
Current inventories are 23.93% higher than the five year average, down from +24.55% at the end of the previous week.
As of July 19th, the net speculative long position in petroleum futures was 174,464,000 barrels, down 27,801,000 barrels (-13.74%) from the previous week. Speculation decreased for the first time in two weeks and represents 19.10% of domestic inventories. Speculation is 12.98% above its one year moving average. The corresponding spot month diesel futures price on July 19th was 131.41 cents per gallon, down 7.91 cents from 146.32 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 25.06% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 6.28% 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 154 million barrels, which is up 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 July 19th, the market price for spot month diesel futures is estimated to be 124.27 versus the actual price of 138.41. This indicates that the market is currently overvalued by 14.14 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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