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Price Up - Inventory Down - Production Down - Speculation Down
During the week ending October 13th, the spot month diesel futures price increased by 5.31 cents per gallon (+3.04%) while the deferred months increased by 4 to 6 cents per gallon making the forward pricing curve higher and virtually unchanged in slope. The one year forward price ended the week at a 5.87 cent discount to the spot price, from a premium of 5.77 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates higher demand expectations and steady inventories with respect to demand. Demand also includes speculation that was lower on the week. 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 October 13th, the spot month gasoline futures price increased by 6.34 cents per gallon (+4.07%) while the deferred months increased by 3 to 6 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 7.71 cent discount to the spot price, from a discount of 4.57 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. 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 lower on the week which is positive 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 which is positive for price. Domestic production is up 12.19% on a year over year basis. Oil rig count indicating the number of oil wells currently being developed by drilling was lower by 5 on the week which is positive for price.
Weekly US petroleum demand increased by 0.01% during the week ending October 6th. Domestic demand is up by 1.27% vs. one-year ago and demand is currently 4.35% above the five year average.
Domestic production decreased on the week and is 12.19% above year ago levels. The number of operating oil drilling rigs in the US was down 5 and stands at 743 which is 25 lower than the recent high of 768. Currently, this is 427 more than the recent low of 316 in 2016 and 53.82% 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 1,052,000 barrels per day (+12.48%) since the recent low on July 1, 2016 and has decreased by 130,000 barrels per day (-1.35%) 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 October 13th.
Below is the one-year chart of spot gasoline futures prices as of October 13th.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased for the 17th consecutive week and on the week were down by 1.74 million barrels while inventories were expected to decrease by 3.95 million barrels on the week. The five-year average inventory increased by 1.60 million barrels. Inventories decreased vs. the five year average and increased 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 October 6th was 89.2%. Until this returns to normal, diesel and gasoline prices will stay elevated by roughly 10-15 cents per gallon from where they would be. Domestic production dipped from the hurricane but has returned to normal.
: : The market has been supported by the President talking about cancelling the Iran deal. Pulling out of this agreement may re-introduce sanctions against Iran which would include Iran exporting less crude oil. This would be supportive of price.
: : The International Energy Agency indicated that inventories may stop declining which would continue the global glut of oil. This would serve to cap prices and discourage speculation in the market. This would be generally negative for price.
: : Chinese imports in September were the second highest on record. This indicates increased Chinese demand, Chinese stockpiling of crude because of a belief that prices or low or both. This is supportive of demand expectations and price.
: : OPEC's compliance with their supply cuts is at 97% which is unusually high by OPEC standards. This compliance is supportive of price. OPEC is also forecasting that the global oversupply of crude will end in a year. If this were to happen, prices would be higher.
: : The Stock market increased by +0.15% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreased by -0.76% 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.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of October 2017. According to the chart, global supply and demand have essentially rebalanced during the first half of 2017 with a slight deficit and are expected to remain roughly in balance through 2018 with a slight surplus. This means firmer prices moving forward.
Below is the one-year chart US stock market prices as of October 13th.
Below is the one-year chart for the US dollar index as of October 13th.
During the week ended October 6th, total petroleum inventories decreased by 1.74 million barrels vs. a five year average increase of 1.60 million barrels and vs. an expected decrease of 3.95 million barrels. Inventories decreased by 3.34 million barrels vs. the five year average and increased by 2.21 million barrels vs. expectations. Total inventories stand at 817.6 million barrels, down from 819.3 million barrels at the end of the previous week. The five year average inventory is 735.4 million barrels, up from 733.8 million barrels at the end of the previous week.
Current inventories are 11.18% higher than the five year average, down from +11.66% at the end of the previous week.
As of October 10th, the net speculative long position in petroleum futures was 357,642,000 barrels, down 19,552,000 barrels (-5.18%) from the previous week. Speculation decreased for the second week in a row and represents 43.74% of domestic inventories. Speculation is 17.22% above its one year moving average. The corresponding spot month diesel futures price on October 10th was 176.49 cents per gallon, up 1.44 cents from 175.05 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 67.28% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 45.26% 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 305 million barrels, which is up roughly 3 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 October 10th, the market price for spot month diesel futures is estimated to be 204.98 versus the actual price of 176.49. This indicates that the market is currently undervalued by 28.49 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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