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Petroleum Market Commentary - December 5, 2016

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OPEC Deal - Prices Surge - Production Up - Rig Count Up - Inventory Up

DIESEL:

During the week ending December 2nd, the spot month diesel futures price increased by 17.19 cents per gallon (+11.57%) while the deferred months increased by 8 to 17 cent per gallon making the forward pricing curve higher and less positively sloped. The one year forward price ended the week at an 8.92 cent premium to the spot price, from a premium of 13.53 cents at the end of the previous week.

The level and slope of the diesel forward pricing curve indicates higher demand expectations and lower inventories with respect to demand. Demand includes speculative demand which increased 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 December 2nd, the spot month gasoline futures price increased by 18.30 cents per gallon (+13.30%) while the deferred months increased by 13 to 18 cents per gallon making the forward pricing curve higher and less positively sloped. The one year forward price ended the week at a 0.58 cent premium to the spot price, from a premium of 4.94 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 includes speculative demand which was higher on the week.

ANALYSIS:

The US dollar was lower on the week which is positive for price. Inventories on the week were higher which is negative for price. The stock market, as a proxy for demand expectations, was lower which is negative 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 down 5.47% 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.

DEMAND:

Weekly US petroleum demand decreased by 1.38% during the week ending November 25th. Domestic demand is up 0.97% vs. one-year ago and demand is currently 3.03% above the five year average.

PRODUCTION:

Domestic production increased for the third week and is 5.47% below year ago levels. The number of operating oil drilling rigs in the US increase by 3 and stands at 477. This is 161 more than the recent low of 316 and 70.35% lower than the peak of 1609 in October 2014. This is a new ten-month high rig count. A higher rig count is negative for price. The increasing rig count is causing US production to stabilize and grow as the global rebalancing of supply and demand continues. US domestic production has decreased by 520,000 barrels per day since the beginning of the year and 911,000 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 December 2nd.



Below is the one-year chart of spot gasoline futures prices as of December 2nd.

MARKET FACTORS & COMMENTARY:

: :  Inventories increased by 6.17 million barrels while inventories were expected to increase by 3.33 million barrels on the week. The five-year average inventory increased by 4.42 million barrels. Inventories increased vs. the five year average and vs. expectations.

: :  The market has been moving up and down in anticipation of OPEC's decision on whether to cut production as a group and if so, by how much. Prices have moved up and down on the bits and pieces of news are released. The movements have been a function of the probability and magnitude of a cut in OPEC production. It is not clear whether and to what extent OPEC will be able to agree to cut and then there is the enforcement piece. Optimism that they can make and keep and enforce a production cut agreement is low.

: :  OPEC confounded its doubters and sent crude oil prices soaring by agreeing to its first production cuts in eight years.

The deal, designed to drain record global oil inventories, overcame disagreements between the group's three largest producers -- Saudi Arabia, Iran and Iraq -- and ended a flirtation with free markets that started in 2014. It was also broader than many had expected, extending beyond OPEC. Most strikingly, Russia agreed to unprecedented cuts to its own output.

The impact on the energy world was immediate: benchmark oil prices gained as much as 10 percent in New York and the share prices of energy companies around the globe jumped alongside the currencies of large exporters. Whether that's sustained will depend on how strictly members of the Organization of Petroleum Exporting Countries stick to the agreement, something they haven't always done in the past.

OPEC will reduce output by about 1.2 million barrels a day by January, the group said, fulfilling a plan sketched out in Algiers in September to cut its production to 32.5 million barrels. The agreement exempted Nigeria and Libya, but gave Iraq its first quotas since the 1990s.

: :  The Stock market decreased by -0.91% which is negative for economic and petroleum demand expectations and prices.

: :  The US Dollar decreasing by -0.71% 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 November and December. 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 December forecast indicates that the speed of rebalancing of supply and demand globally is roughly unchanged from November. This is neutral for price.

NOVEMBER FORECAST

DECEMBER FORECAST



Below is the one-year chart US stock market prices as of December 2nd.



Below is the one-year chart for the US dollar index as of December 2nd.



INVENTORIES:

During the week ended November 25th, total petroleum inventories increased by 6.17 million barrels vs. a five year average increase of 4.42 million barrels and vs. an expected increase of 3.33 million barrels. Inventories increased by 1.75 million barrels vs. the five year average and increased by 2.84 million barrels vs. expectations. Total inventories stand at 868.5 million barrels, up from 862.3 million barrels at the end of the previous week. The five year average inventory is 702.8 million barrels, up from 698.4 million barrels at the end of the previous week.

Current inventories are 23.57% higher than the five year average, up from +23.46% at the end of the previous week.



SPECULATION:

As of November 29th, the net speculative long position in petroleum futures was 220,509,000 barrels, up 11,813,000 barrels (+5.66%) from the previous week. Speculation increased for the second week and represents 25.39% of domestic inventories. Speculation is 14.18% above its one year moving average. The corresponding spot month diesel futures price on November 29th was 146.27 cents per gallon, down 6.36 cents from 152.63 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 75.68% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 57.27% 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 193 million barrels, which is up about 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 November 29th, the market price for spot month diesel futures is estimated to be 116.73 versus the actual price of 146.27. This indicates that the market is currently overvalued by 29.54 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.