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Petroleum Market Commentary - October 31, 2016

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OPEC Impotent - Prices Lower - Speculation Lower - Inventories Down

DIESEL:

During the week ending October 28th, the spot month diesel futures price decreased by 3.18 cents per gallon (-2.02%) while the deferred months increased by 1 to 4 cent per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at an 11.83 cent premium to the spot price, from a premium of 11.70 cents at the end of the previous week.

The 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 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.

GASOLINE:

During the week ending October 28th, the spot month gasoline futures price decreased by 6.23 cents per gallon (-4.07%) 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 2.45 cent premium to the spot price, from a premium of 0.26 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.

ANALYSIS:

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 lower which is negative 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 6.67% on a year over year basis. Oil rig count indicating the number of oil wells currently being developed by drilling was lower on the week which is positive for price.

DEMAND:

Weekly US petroleum demand increased by 3.80% during the week ending October 21st. Domestic demand is up 4.29% vs. one-year ago and demand is currently 5.38% above the five year average.

PRODUCTION:

Domestic production increased for the second week after reaching a nine week low. Current production is 6.67% below year ago levels. The number of operating oil drilling rigs in the US decreased for the first time in four months and stands at 441 which is 2 less than the previous week, 125 more than the recent low of 316 and 72.59% lower than the peak of 1609 in October 2014. A lower rig count is positive for price. The increasing rig count is causing US production to stabilize as the global rebalancing of supply and demand continues. US domestic production has decreased by 715,000 barrels per day since the beginning of the year and 1,106,000 barrels per day 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 28th.



Below is the one-year chart of spot gasoline futures prices as of October 28th.

MARKET FACTORS & COMMENTARY:

: :  Inventories decreased by 5.86 million barrels while inventories were expected to decrease by 0.71 million barrels on the week. The five-year average inventory decreased by 1.49 million barrels. Inventories decreased vs. the five year average and vs. expectations.

: :  OPEC's ability to put a plan in place to curtail supply is in serious doubt as meetings over the weekend have been unfruitful and increase the likelihood that supply will not be meaningfully cut. This will cause prices to decline as speculation over OPEC cuts will decrease. Russia is resisting cuts too such that if OPEC makes cuts, the supply will be made up by other suppliers at current prices.

: :  The Stock market decreased by -0.69% which is negative for economic and petroleum demand expectations and prices.

: :  The US Dollar decreasing by -0.35% 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.



The charts below show supply and demand history and expectations for September and October. Supply and demand are in the process of re-balancing which is the main cause of steady to higher price levels over the past 6 months. The September and October forecasts indicate that the rebalancing of supply and demand globally will occur in 2017 which would be supportive of price. When the two forecasts are compared, the October forecast shows an expectation of a slightly higher surplus through the second quarter of 2017 which is negative for price.

SEPTEMBER FORECAST

OCTOBER FORECAST



Below is the one-year chart US stock market prices as of October 28th.



Below is the one-year chart for the US dollar index as of October 28th.



INVENTORIES:

During the week ended October 21st, total petroleum inventories decreased by 5.86 million barrels vs. a five year average decrease of 1.49 million barrels and vs. an expected decrease of 0.71 million barrels. Inventories decreased by 4.37 million barrels vs. the five year average and decreased by 5.15 million barrels vs. expectations. Total inventories stand at 846.5 million barrels, down from 852.4 million barrels at the end of the previous week. The five year average inventory is 700.2 million barrels, down from 701.8 million barrels at the end of the previous week.

Current inventories are 20.89% higher than the five year average, down from +21.47% at the end of the previous week.



SPECULATION:

As of October 25th, the net speculative long position in petroleum futures was 321,275,000 barrels, down 18,702,000 barrels (-5.50%) from the previous week. Speculation decreased for the first time in five weeks and represents 37.95% of domestic inventories. Speculation is 77.12% above its one year moving average. The corresponding spot month diesel futures price on October 25th was 156.31 cents per gallon, down 0.55 cents from 156.86 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 64.03% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 40.99% 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 340 million barrels with an average of about 181 million barrels, which is up about 2 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 25th, the market price for spot month diesel futures is estimated to be 149.21 versus the actual price of 156.31. This indicates that the market is currently overvalued by 7.09 cents per gallon given the assumptions of the pricing model.



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.