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Speculation Up - Prices Down - Rig Count Up - Inventories Balloon
During the week ending January 6th, the spot month diesel futures price decreased by 2.50 cents per gallon (-1.45%) while the deferred months changed by +1 to -2 cents per gallon making the forward pricing curve about unchanged in level and more positively sloped. The one year forward price ended the week at a 9.89 cent premium to the spot price, from a premium of 7.79 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates steady demand expectations and larger 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.
During the week ending January 6th, the spot month gasoline futures price decreased by 3.69 cents per gallon (-2.21%) while the deferred months decreased by 1 to 3 cents per gallon making the forward pricing curve lower and less negatively sloped over the next year. The one year forward price ended the week at a 3.04 cent discount to the spot price, from a discount of 4.64 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. Demand includes speculative demand which was higher on the week.
The US dollar was virtually unchanged on the week which is neutral 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 higher which is negative for price. Domestic production is down 4.87% 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.
Weekly US petroleum demand decreased by 11.08% during the week ending December 30th. Domestic demand is down 0.54% vs. one-year ago and demand is currently 4.71% above the five year average.
Domestic production increased for the first time in three weeks and is 4.87% below year ago levels. The number of operating oil drilling rigs in the US increase by 4 and stands at 529. This is 213 more than the recent low of 316 and 67.12% lower than the peak of 1609 in October 2014. This is a new twelve-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 449,000 barrels per day since the beginning of the year and 840,000 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 January 6th.
Below is the one-year chart of spot gasoline futures prices as of January 6th.
MARKET FACTORS & COMMENTARY:
: : Inventories increased by 11.31 million barrels while inventories were expected to decrease by 0.16 million barrels on the week. The five-year average inventory increased by 12.10 million barrels. Inventories decreased vs. the five year average and increased vs. expectations.
: : The Stock market increased by +1.70% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by +0.01% 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.
SUPPLY & DEMAND:
The charts below show supply and demand history and expectations for December and January. 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 January forecast shows a more balanced market than the December forecast due to expected OPEC cuts.
Below is the one-year chart US stock market prices as of January 6th.
Below is the one-year chart for the US dollar index as of January 6th.
During the week ended December 30th, total petroleum inventories increased by 11.31 million barrels vs. a five year average increase of 12.10 million barrels and vs. an expected decrease of 0.16 million barrels. Inventories decreased by 0.79 million barrels vs. the five year average and increased by 11.46 million barrels vs. expectations. Total inventories stand at 876.1 million barrels, up from 864.8 million barrels at the end of the previous week. The five year average inventory is 724.3 million barrels, down from 712.2 million barrels at the end of the previous week.
Current inventories are 20.97% higher than the five year average, down from +21.44% at the end of the previous week.
Speculation rises to a new 30 month high.
As of January 3rd, the net speculative long position in petroleum futures was 404,906,000 barrels, up 13,365,000 barrels (+3.41%) from the previous week. Speculation increased for the seventh week and represents 46.21% of domestic inventories. Speculation is 82.32% above its one year moving average. The corresponding spot month diesel futures price on January 3rd was 167.67 cents per gallon, down 2.27 cents from 169.94 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 80.93% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 65.50% 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 405 million barrels with an average of about 222 million barrels, which is up about 6 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 3rd, the market price for spot month diesel futures is estimated to be 139.30 versus the actual price of 167.67. This indicates that the market is currently overvalued by 28.37 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.