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Prices Down - Speculation Higher - Inventories Balloon - Steeper Curve
During the week ending December 29th, the spot month diesel futures price decreased by 5.43 cents per gallon (-2.77%) while the deferred months were changed by +1 to -4 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 6.15 cent premium to the spot price, from a premium of 3.09 cents at the end of the previous week.
The change in level and slope of the diesel forward pricing curve indicates lower demand expectations and higher supplies with respect to demand. Demand includes speculative demand which was higher 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.
During the week ending December 26th, the spot month gasoline futures price decreased by 5.08 cents per gallon (-3.26%) while the deferred months changed by +1 to -5 cents per gallon making the forward pricing curve mostly lower and more positively sloped. The one year forward price ended the week at a 13.42 cent premium to the spot price, from a premium of 8.53 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.
The US dollar increased 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 on the week which is positive for price. Domestic production is up 12.53% year over year.
The market continues lower and inventories continue to grow. This will have the effect that OPEC intends and that is less competition in oil production brought on by lower prices and lower non-OPEC production as oil production becomes less financially attractive.
Weekly US petroleum demand increased by 2.80% during the week ending December 19th. Domestic demand is up 0.97% vs. one-year ago and demand is currently 2.90% over the five year average.
The attractiveness of making new hedges was higher on the week as prices were lower while speculation was higher. From a flat-price basis, prices remain very attractive at five-year lows. The market should find medium-term support at current prices since prices are very near to the marginal cost of some production which will act like a price floor and mitigate the risk of significant opportunity cost in new hedging. In the short-term as global production begins to slow but has not declined enough to offset the current over-supply, spot and nearby prices can move lower while prices further forward on the curve will not move lower as quickly if at all. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging may become more attractive.
Domestic production was lower on the week from its new 40 year high level during the previous week. The number of operating oil drilling rigs in the US has started to decline. This will limit production growth and may cause sustained declines in production which would help in balancing supply and demand in the market.
Below is the one-year chart of spot diesel futures prices as of December 26th.
Below is the one-year chart of spot gasoline futures prices as of December 26th.
: : Inventories increasing by 13.65 million barrels while inventories were expected to decrease by 1.90 million barrels on the week. The five-year average inventory decreased by 0.89 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : The market continues to be oversupplied by about two million barrels per day. The Saudi oil minister indicated that they will be maintaining production regardless of price in order to maintain their market share. The market may take some time to digest this new reality and spot prices may remain relatively low until the two million barrel per day surplus is corrected either by higher demand, lower supply or a combination of the two. Inventories are growing and are absorbing some of the excess. Demand is increasing which is absorbing some excess, and growth in production has slowed which lessening the rate of growth of oversupply.
: : The upward revision of US third quarter GDP to 5% shows that the US economy is more robust than expected. This is supportive of higher petroleum demand expectations and price.
: : Stock market increasing by 0.88% on the week to another all-time high is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by 0.48% to an eight year high. This 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.
Below is the one-year chart US stock market prices as of December 26th.
Below is the one-year chart US dollar prices as of December 26th.
During the week ended December 19th, total petroleum inventories increased by 13.65 million barrels vs. a five year average decrease of 0.89 million barrels and vs. an expected decrease of 1.90 million barrels. Inventories increased by 14.54 million barrels vs. the five year average. Total inventories stand at 737.2 million barrels, up from 723.5 million barrels at the end of the previous week. The five year average inventory is 703.4 million barrels, down from 704.3 million barrels at the end of the previous week.
Current inventories are 4.79% higher than the five year average, up from +2.72% at the end of the previous week. Inventory levels are growing due to excess supply and low price where those who hold inventories are accumulating more which is essentially increasing a long position in the market.
As of December 23rd, the net speculative long position in petroleum futures was 231,575,000 barrels down 11,451,000 barrels (-4.71%) from the previous week. Speculation decreased for the first time in four weeks and represents 31.41% of domestic inventories. Speculation is 48.80% below its one year moving average. The corresponding spot month diesel futures price on December 23rd was 199.07 cents per gallon, up 3.07 cents from 196.00 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 67.08% correlated over the past 52 weeks (a decrease on the week as prices continue lower but speculation moves higher) indicating that, on a statistical basis over the past year 45.00% of the price movement of diesel fuel is explained by changes in levels of speculation. A linear regression analysis over the past 52 weeks shows that if speculation were zero and the market forces causing speculation evaporated, that the spot month diesel futures price would be 221.06 cents per gallon or 21.99 cents per gallon more than current prices. The analysis would indicate that about -10.20% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 4 cents lower on the week.
The net speculative long position has been variable over the past year ranging between 166 million and 453 million barrels with an average of about 308 million barrels, which is down about 2 million barrels on the week.
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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