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Prices Down - Speculation Lower - Dollar Stronger
During the week ending January 2nd, the spot month diesel futures price decreased by 8.85 cents per gallon (-4.70%) while the deferred months declined by 4 to 8 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 12.68 cent premium to the spot price, from a premium of 8.97 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 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.
During the week ending January 2nd, the spot month gasoline futures price decreased by 9.13 cents per gallon (-5.99%) while the deferred months decreased by 4 to 9 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 17.71 cent premium to the spot price, from a premium of 13.94 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 sharply 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 lower which is positive for price. Speculation was lower on the week which is negative for price. US domestic crude production was lower on the week which is positive for price. Domestic production is up 12.31% year over year.
Weekly US petroleum demand decreased by 5.22% during the week ending December 26th. Domestic demand is up 2.35% vs. one-year ago and demand is currently 5.13% over the five year average.
The attractiveness of making new hedges was higher on the week as prices and speculation were both lower. 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. This will cause the forward pricing curve to become more positively sloped as we have seen. 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 slightly lower on the week from its recent 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 January 2nd.
Below is the one-year chart of spot gasoline futures prices as of January 2nd.
: : Inventories increasing by 3.07 million barrels while inventories were expected to increase by 3.51 million barrels on the week. The five-year average inventory increased by 1.58 million barrels. Inventories increased vs. the five year average and decreased vs. expectations.
: : The market continues to be oversupplied by about two million barrels per day. Until the market solves this problem through price adjustments to decrease supply and/or increase demand to absorb the excess, prices will remain low and the forward pricing curve will remain significantly positively sloped.
: : Libyan production has fallen below 300,000 barrels per day, the lowest level in 7 months due to a militant attack and ensuing fire. This is negative for supply and is supportive of price at the margin.
: : Russia and Iraq reported increases in production in December and Russia to a new post-Soviet high level. More supply on the global market is negative for price.
: : Weaker than expected US manufacturing report from the Institute of supply management (ISM) shows relative weakness in the US manufacturing which is negative for economic growth expectations, petroleum demand expectations and petroleum price.
: : Stock market decreasing by 1.46% on the week is negative for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by 1.17% to a nine 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 January 2nd.
Below is the one-year chart for the US dollar index as of January 2nd.
During the week ended December 26th, total petroleum inventories increased by 3.07 million barrels vs. a five year average increase of 1.58 million barrels and vs. an expected increase of 3.51 million barrels. Inventories increased by 1.49 million barrels vs. the five year average. Total inventories stand at 740.2 million barrels, up from 737.2 million barrels at the end of the previous week. The five year average inventory is 705.0 million barrels, up from 703.4 million barrels at the end of the previous week.
Current inventories are 4.99% higher than the five year average, up from +4.79% 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. Those who hold inventories have an incentive to do so since forward prices are higher than spot prices, holders of inventory can earn an attractive guaranteed return on their investment.
As of December 30th, the net speculative long position in petroleum futures was 216,527,000 barrels down 15,048,000 barrels (-6.50%) from the previous week. Speculation decreased for the second week in a row and represents 29.25% of domestic inventories. Speculation is 29.20% below its one year moving average. The corresponding spot month diesel futures price on December 30th was 186.88 cents per gallon, down 12.19 cents from 199.07 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 65.75% correlated over the past 52 weeks (a decrease on the week as prices continue lower but speculation remains relatively high) indicating that, on a statistical basis over the past year 43.23% 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 216.07 cents per gallon or 29.19 cents per gallon more than current prices. The analysis would indicate that about -15.62% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 5 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 306 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.