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Petroleum Market Commentary - November 12, 2018

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Dollar Higher - Speculation Plummets - Production Higher - Stock Market Higher - Inventory High vs. FYA - Prices Lower

DIESEL:

During the week ending November 9th, the spot month diesel futures price was unchanged while the deferred months changed between -2 and +3 cents per gallon making the forward pricing curve steady and relatively unchanged in slope. The one year forward price ended the week at a 0.08 cent discount to the spot price, from a premium of 0.93 cents at the end of the previous week.

The level and slope of the diesel forward pricing curve indicates steady current demand expectations and steady inventories with respect to demand. Demand also includes speculation which was lower 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 November 9th, the spot month gasoline futures price decreased by 8.69 cents per gallon (-5.09%) while the deferred months decreased by 7-10 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 5.37 cent premium to the spot price, from a premium of 4.64 cents and the end of the previous week.

The change in level and shape of this forward pricing curve indicates lower current demand expectations and higher inventory levels with respect to supply and demand. Demand also includes speculation which was lower on the week.

ANALYSIS:

DEMAND:

Weekly US petroleum demand decreased by 2.91% during the week ending November 2nd. Domestic demand is up by 4.01% vs. one-year ago and demand is currently 2.72% above the five year average.

PRODUCTION:

Domestic production spiked to a new all-time high level on the week and is 20.58% above year ago levels. The number of operating oil drilling rigs in the US increased from 874 to 886 on the week. Currently, this is 570 more than the low of 316 rigs in 2016 and 44.93% lower than the peak of 1609 in October 2014. This high and increasing rig count is causing US production to generally grow and is a factor in buffering supply disruptions in other parts of the world. US domestic production has increased by 3,172,000 barrels per day (+37.64%) since the low on July 1, 2016.









Below is the one-year chart of spot diesel futures prices as of November 9th.



Below is the one-year chart of spot gasoline futures prices as of November 9th.

MARKET FACTORS & COMMENTARY:

: :  Petroleum inventories increased on the week by 4.17 million barrels while inventories were expected to decrease by 1.71 million barrels on the week. The five-year average inventory decreased by 1.40 million barrels. Inventories increased vs. the five year average and decreased vs. expectations.

: :  The US announced that a number of countries will be receiving waivers on the Iranian sanctions and will be permitted to purchase oil from Iran for a limited period of time. These waivers are being granted since not importing oil from Iran may damage the economies of the countries requesting waiver and it might also pinch global supply causing a price spike. Waivers mean that there will be more supply than was expected which is negative for price.

: :  OPEC + Friends is considering a cut in production given the expectation of a supply glut in 2019. In light of growing inventories and increasing US production, OPEC is beginning to see the need to curtail production in order to sustain prices at current levels. Of course, we have seen this movie before where OPEC cuts production not to drain global inventories to normal levels as we saw two years ago but to sustain price. OPEC did this from 2011 to 2014 and caused the expansion of US shale output. If OPEC cuts its output now, will US shale production and other production around the globe increase to drive prices lower? We shall see.

: :  US inventories are at year to date highs when viewed versus the five year average. Higher inventory levels are negative for price.

: :  With these negative market factors, speculation has decreased to a 14-month low since investors see less upside in petroleum prices at this time. Oddly, speculation and price are negatively correlated over the past year meaning that over the past year, price has not been affected by levels of speculation.

: :  The Stock market increased by +2.13% which is positive for general economic activity and is positive for petroleum prices.

: :  The US Dollar increased by +0.38% on the week which 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.



OPEC Production Five Year History - Up 1.53 million barrels per day from May to October.



SUPPLY & DEMAND:

The chart below shows supply and demand history and expectations as of November 2018. According to the chart, global supply has been about 600,000 barrels per day less than consumption for the past year but roughly balanced for the fourth quarter of 2018 and then a surplus of 500,000 barrels per day is forecasted for 2019. In earlier forecasts, there was less of a surplus for the remainder of 2018 and 2019 meaning that this updated forecast is less supportive of price and may contribute to the next round of production cuts from OPEC + Friends.

NOVEMBER FORECAST



Below is the one-year chart US stock market prices as of November 9th.



Below is the one-year chart for the US dollar index as of November 9th.



INVENTORIES:

During the week ended November 2nd, total petroleum inventories increased by 4.17 million barrels vs. a five year average decrease of 1.40 million barrels and vs. an expected decrease of 1.71 million barrels. Inventories increased by 5.57 million barrels vs. the five year average and increased by 5.88 million barrels vs. expectations. Total inventories stand at 782.7 million barrels, up from 778.5 million barrels at the end of the previous week. The five year average inventory is 761.5 million barrels, down from 762.9 million barrels at the end of the previous week.

Current inventories are +2.77% versus the five year average, up from +2.04% at the end of the previous week. Inventory has been growing vs. the five year average since August and is the highest vs. FYA since January 5th.



SPECULATION:

14-month low speculation.

As of November 6th, the net speculative long position in petroleum futures was 256,806,000 barrels, down 47,017,000 barrels (-15.48%) from the previous week. Speculation decreased for the fifth week and represents 32.81% of domestic inventories. Speculation is 52.05% below its one year moving average. The corresponding spot month diesel futures price on November 6th was 218.83 cents per gallon, down 7.15 cents from 225.98 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are -44.31% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 19.63% of diesel fuel price movements are explained by changes in level of speculation. One-year correlation has declined sharply in the past several months and is now significantly which is very unusual.

The net speculative long position has been variable over the past year ranging between 256 million and 703 million barrels with an average of about 536 million barrels, which is down 3 million barrels on the week. This is the first decrease in the one year average in quite some time.

Based on a multiple regression analysis considering the level of the dollar, speculation, and inventory over the past five years as of November 6th, the market price for spot month diesel futures is estimated to be 168.99 versus the actual price of 218.83. This indicates that the market is currently overvalued by 49.84 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.