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Speculation Lower - Production Higher - Inventory Higher - Prices Steady
During the week ending January 5th, the spot month diesel futures price decreased by 0.94 cents per gallon (-0.45%) while the deferred months increased by 1-3 cents per gallon making the forward pricing curve steady and less negative in slope. The one year forward price ended the week at a 9.02 cent discount to the spot price, from a discount of 12.16 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates higher demand expectations and higher 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.
During the week ending January 5th, the spot month gasoline futures price decreased by 1.00 cent per gallon (-0.56%) while the deferred months increased by 0 to 1 cent per gallon making the forward pricing curve steady and less negatively sloped. The one year forward price ended the week at a 6.78 cent discount to the spot price, from a discount of 9.31 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates steady demand expectations and higher inventory levels with respect to supply and demand. Demand also includes speculation which was lower on the week.
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 higher which is positive for price. Speculation was lower on the week which is negative for price. US domestic crude production was higher which is negative for price. Domestic production is up 11.54% on a year over year basis. Oil rig count, indicating the number of oil wells currently being developed, was lower on the week which is positive for price.
Weekly US petroleum demand decreased by 3.99% during the week ending December 29th. Domestic demand is up by 5.02% vs. one-year ago and demand is currently 9.38% above the five year average.
Domestic production increased on the week and is 11.54% above year ago levels. The number of operating oil drilling rigs in the US was lower by 5 to 742 which is 26 lower than the recent high of 768. Currently, this is 426 more than the recent low of 316 in 2016 and 53.88% lower than the peak of 1609 in October 2014. The relatively high rig count is causing US production to grow as the global rebalancing of supply and demand and the return of global inventories to normal levels continues. US domestic production has increased by 1,354,000 barrels per day (+16.07%) since the recent low on July 1, 2016 and has increased past the old high from June 2015 of 9.61 million barrels per day.
Below is the one-year chart of spot diesel futures prices as of January 5th.
Below is the one-year chart of spot gasoline futures prices as of January 5th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories increased on the week by 6.29 million barrels while inventories were expected to decrease by 2.54 million barrels on the week. The five-year average inventory increased by 12.48 million barrels. Inventories decreased vs. the five year average and increased vs. expectations.
: : The North Sea pipeline that was halted due to a hairline crack on December 11th has resumed operation. This removes this supply constraint and is negative for price.
: : Protests in Iran have increased geopolitical risk and the likelihood of supply disruption from this country that produces 3.8 million barrels per day. While supply was not disrupted, this risk is positive for price.
: : Frigid temperatures in the Northeast have increased demand for heating oil sending prices higher. As the weather normalizes, the effects on price will disappear. Weather related events such as this that increase price are helped along by speculation.
: : The pace of global economic growth has increased which boosts petroleum demand expectations and price. As other economies’ growth rates rise in comparison to the US, the dollar becomes weaker which is also positive for price. So in the same way lower economic growth and stronger dollar had a multiplied negative effect on price in 2014-2015, the opposite is happening now.
: : OPEC production was steady in December and compliance with the production quotas were greater than 100%. This is supportive of price. It will be interesting to see how compliance holds together in an environment of higher prices.
: : The Stock market increased by +2.60% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreased by -0.19% 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.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of January 2018. According to the chart, global supply and demand have essentially rebalanced and there was a deficit of about 0.5 million barrels per day in 2017. Moving forward into 2018 and 2019, balance or a slight surplus is expected. The 2017 deficit has been supportive of price. Balance to slight surplus moving forward is neutral to negative for price.
Below is the one-year chart US stock market prices as ofJanuary 5thd.
Below is the one-year chart for the US dollar index as ofJanuary 5thd.
During the week ended December 29th, total petroleum inventories increased by 6.29 million barrels vs. a five year average increase of 12.48 million barrels and vs. an expected decrease of 2.54 million barrels. Inventories decreased by 6.18 million barrels vs. the five year average and increased by 8.83 million barrels vs. expectations. Total inventories stand at 796.5 million barrels, up from 790.2 million barrels at the end of the previous week. The five year average inventory is 763.4 million barrels, up from 750.9 million barrels at the end of the previous week.
Current inventories are 4.33% higher than the five year average, down from +5.23% at the end of the previous week.
As of January 2nd, the net speculative long position in petroleum futures was 569,265,000 barrels, down 3,981,000 barrels (-0.69%) from the previous week. Speculation decreased for the first time in two weeks and represents 71.47% of domestic inventories. Speculation is 63.15% above its one year moving average. The corresponding spot month diesel futures price on January 2nd was 205.84 cents per gallon, up 1.99 cents from 203.85 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 79.52% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 63.24% 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 81 million and 574 million barrels with an average of about 342 million barrels, which is up roughly 4 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 January 2nd, the market price for spot month diesel futures is estimated to be 233.29 versus the actual price of 205.84. This indicates that the market is currently undervalued by 27.45 cents per gallon given the assumptions of the pricing model.
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.