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Dollar Up - Inventory Down - Production Up - Speculation Up
During the week ending September 29th, the spot month diesel futures price decreased by 0.46 cents per gallon (-0.25%) while the deferred months changed between up 1 and down 2 cents per gallon making the forward pricing curve virtually unchanged in level and slope. The one year forward price ended the week at a 9.05 cent discount to the spot price, from a premium of 9.15 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates steady demand expectations and steady inventories with respect to demand. Spot prices continue to be elevated with respect to forward prices due to refining capacity continuing to be off line due to Hurricane Harvey. 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 September 29th, the spot month gasoline futures price decreased by 6.19 cents per gallon (-3.71%) while the deferred months decreased by 1 to 4 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 5.42 cent discount to the spot price, from a discount of 10.92 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 also includes speculation which was higher on the week. We continue to see elevated spot and near-term prices and not in further forward prices due to refining capacity that continues to be shut-in after hurricane Harvey.
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 higher on the week which is positive for price. US domestic crude production was higher which is negative for price. Domestic production is up 12.36% on a year over year basis. Oil rig count indicating the number of oil wells currently being developed by drilling was higher by 6 on the week which is negative for price.
Weekly US petroleum demand increased by 3.21% during the week ending September 22nd. Domestic demand is up by 1.28% vs. one-year ago and demand is currently 6.22% above the five year average.
Domestic production increased on the week and is 12.36% above year ago levels. The number of operating oil drilling rigs in the US was up 6 and stands at 750 which is 18 lower than the recent high of 768. Currently, this is 434 more than the recent low of 316 in 2016 and 53.39% lower than the peak of 1609 in October 2014. The relatively high rig count is causing US production to grow as the global rebalancing of supply and demand continues. US domestic production has increased by 1,119,000 barrels per day (+13.28%) since the recent low on July 1, 2016 and has decreased by 63,000 barrels per day (-0.66%) since the peak of 9.61 million barrels per day in June 2015.
Below is the one-year chart of spot diesel futures prices as of September 29th.
Below is the one-year chart of spot gasoline futures prices as of September 29th.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased for the fifteenth consecutive week and on the week were down by 1.55 million barrels while inventories were expected to decrease by 0.87 million barrels on the week. The five-year average inventory increased by 0.46 million barrels. Inventories decreased vs. the five year average and vs. expectations.
: : The effects of hurricane Harvey are still being felt as domestic production and refining capacity utilization continue to come back to normal. From August 25th to September 8th, refining capacity utilization dropped from 96.60% to 77.70% and as of September 22nd, 88.60%. Until this returns to normal, diesel and gasoline prices will stay elevated by roughly 15 cents per gallon from where they would be. Domestic production dipped from the hurricane but has returned to normal.
: : The Kurdish vote for independence caused fear of supply disruption as Turkey threatened to halt shipments from northern Iraq if the Kurds voted to separate from Iraq. They did vote for independence and Turkey did nothing.
: : The Stock market increased by +0.68% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increased by +0.98% 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.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of September 2017. According to the chart, global supply and demand have essentially rebalanced during the first half of 2017 and are expected to remain roughly in balance through 2018 with a slight surplus. This means firmer prices moving forward. There will need to be a period of deficit in order to deplete global inventories that have accumulated over the past several years. When, if, and to what extend this happens, prices will rise and we will return to a market more akin to 2012-2014 with high prices and backward forward pricing curves.
Below is the one-year chart US stock market prices as of September 29th.
Below is the one-year chart for the US dollar index as of September 29th.
During the week ended September 22nd, total petroleum inventories decreased by 1.55 million barrels vs. a five year average increase of 0.46 million barrels and vs. an expected decrease of 0.87 million barrels. Inventories decreased by 2.01 million barrels vs. the five year average and decreased by 0.68 million barrels vs. expectations. Total inventories stand at 826.3 million barrels, down from 827.9 million barrels at the end of the previous week. The five year average inventory is 732.7 million barrels, up from 732.2 million barrels at the end of the previous week.
Current inventories are 12.78% higher than the five year average, down from +13.07% at the end of the previous week.
As of September 26th, the net speculative long position in petroleum futures was 385,280,000 barrels, up 54,341,000 barrels (+16.42%) from the previous week. Speculation increased for the second week in a row and represents 46.63% of domestic inventories. Speculation is 27.16% above its one year moving average. The corresponding spot month diesel futures price on September 26th was 184.53 cents per gallon, up 7.27 cents from 177.26 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 67.70% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 45.84% 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 81 million and 488 million barrels with an average of about 299 million barrels, which is up roughly 5 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 September 26th, the market price for spot month diesel futures is estimated to be 207.83 versus the actual price of 184.53. This indicates that the market is currently undervalued by 23.30 cents per gallon given the assumptions of the pricing model.
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