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Petroleum Market Commentary - December 12, 2016

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Speculation Spikes Up - Prices Down - Rig Count Up - Inventory Up

DIESEL:

During the week ending December 9th, the spot month diesel futures price decreased by 2.07 cents per gallon (-1.25%) while the deferred months decreased by 2 to 7 cent per gallon making the forward pricing curve lower and less positively sloped. The one year forward price ended the week at an 8.78 cent premium to the spot price, from a premium of 8.92 cents at the end of the previous week.

The level and slope of the diesel forward pricing curve indicates lower 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 9th, the spot month gasoline futures price decreased by 5.18 cents per gallon (-3.32%) while the deferred months decreased by 3 to 5 cents per gallon making the forward pricing curve lower and more positively sloped over the next year. The one year forward price ended the week at a 2.42 cent premium to the spot price, from a premium of 0.58 cents and the end of the previous week.

The change in level and shape of this forward pricing curve indicates lower 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 higher on the week which is negative for price. Inventories on the week were higher which is negative 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 lower which is positive for price. Domestic production is down 5.10% 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 3.32% during the week ending December 2nd. Domestic demand is down 0.99% vs. one-year ago and demand is currently 1.52% above the five year average.

PRODUCTION:

Domestic production decreased for the first time in four weeks and is 5.10% below year ago levels. The number of operating oil drilling rigs in the US increase by 21 and stands at 498. This is 182 more than the recent low of 316 and 69.05% 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 522,000 barrels per day since the beginning of the year and 913,000 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 9th.



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

MARKET FACTORS & COMMENTARY:

: :  Inventories increased by 3.54 million barrels while inventories were expected to increase by 1.46 million barrels on the week. The five-year average inventory increased by 5.59 million barrels. Inventories decreased vs. the five year average and increased vs. expectations.

: :  OPEC production increased to a new high of 34.16 million barrels per day in November. This ahead of the cartel's proposed cuts starting in January.

: :  OPEC succeeded in persuading non-OPEC producers to cut 600,000 barrels per day of production in addition to the 1.2 million barrels per day of production promised by its own members for a total cut of 1.8 million barrels per day.

: :  China has been building their oil stockpiles for the past two years as prices have been low. With rising prices, China demand may be growing as they draw down the stockpiles. This would cause demand growth to be lower than expected which would be negative for price.

: :  With OPEC and non-OPEC cuts, the global oil market is expected to become balanced in 2017 where daily consumption and production are equal. Even if this happens, the large inventories of oil that have accumulated over the past two years will still be present and would weigh on prices. The market would need to be in a deficit where demand would exceed supply for an extended period of time in order for excess inventories to disappear. This market condition would almost certainly be in an environment of higher prices where additional production and decreased demand would be expected.

: :  US domestic rig count is higher which indicates continued expansion of US domestic crude production which has been higher since late October. This is, of course, in response to higher prices and promised cuts from OPEC. Cuts from OPEC is an invitation to US producers to ramp up production.

: :  Since July, hedging activity from producers has increased by 174 million barrels. This is in response to higher prices and the ability of mostly American producers to lock in revenues for the next several years in the $55 per barrel price range: a price at which they can make money. Interestingly, speculation has increased by 194 million barrels during the same time. This means that speculation has driven price up to where hedgers are selling into the market meaning that prices will go lower when speculators, realizing that their upside price potential is limited by producer hedging, liquidate their positions. However, there is a high likelihood that a good portion of the hedging results in increased production which will drive prices lower. Even if OPEC can avoid cheating on its quotas (which it probably won't avoid) domestic US production will rise to offset a portion of OPEC cuts which will weigh on prices causing OPEC's strategy to fail. Due to the decrease in marginal cost of production in the US and the speed at which production can be increased, there is no price at which OPEC solves their problems. The ramping up of US production will defeat the OPEC strategy and the increase in hedging activity indicates this.

: :  The Stock market increased by +3.08% which is positive for economic and petroleum demand expectations and prices.

: :  The US Dollar increasing by +0.81% 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.



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.

SUPPLY & DEMAND:

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.

NOVEMBER FORECAST

DECEMBER FORECAST



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



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



INVENTORIES:

During the week ended December 2nd, total petroleum inventories increased by 3.54 million barrels vs. a five year average increase of 5.59 million barrels and vs. an expected increase of 1.46 million barrels. Inventories decreased by 2.05 million barrels vs. the five year average and increased by 2.08 million barrels vs. expectations. Total inventories stand at 872.0 million barrels, up from 868.5 million barrels at the end of the previous week. The five year average inventory is 708.4 million barrels, up from 702.8 million barrels at the end of the previous week.

Current inventories are 23.09% higher than the five year average, down from +23.57% at the end of the previous week.



SPECULATION:

As of December 6th, the net speculative long position in petroleum futures was 335,248,000 barrels, up 114,739,000 barrels (+52.03%) from the previous week. Speculation increased for the third week and represents 38.45% of domestic inventories. Speculation is 68.91% above its one year moving average. The corresponding spot month diesel futures price on December 6th was 163.79 cents per gallon, up 17.52 cents from 146.27 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 78.25% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 61.23% 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 63 million and 340 million barrels with an average of about 198 million barrels, which is up about 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 December 6th, the market price for spot month diesel futures is estimated to be 137.85 versus the actual price of 163.79. This indicates that the market is currently overvalued by 25.94 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.