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Prices Higher - Inventory Higher - Rig Count Lower
During the week ending February 13th, the spot month diesel futures price increased by 13.23 cents per gallon (+7.19%) while the deferred months increased by 4 to 11 cents per gallon making the forward pricing curve higher and less positively sloped. The one year forward price ended the week at a 4.76 cent premium to the spot price, from a premium of 11.21 cents at the end of the previous week.
The change in level and slope of the diesel forward pricing curve indicates higher demand expectations and lower 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 February 13th, the spot month gasoline futures price increased by 6.71 cents per gallon (+4.30%) while the deferred months increased by 3 to 6 cents per gallon making the forward pricing curve higher and relatively less positive in slope. The one year forward price ended the week at an 10.87 cent premium to the spot price, from a premium of 14.20 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates higher demand expectations and lower inventory levels with respect to supply and demand.
The US dollar decreased 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 on the week which is negative for price. Domestic production is up 13.45% year over year.
The attractiveness of making new hedges decreased as prices were higher. From a flat-price basis, prices remain very attractive when compared to the last four years. The market has found a short to medium-term bottom. In the short-term, global production will begin to slow and demand will increase but not enough to offset the current surplus of production and prices may weaken again and decrease to January's lows. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging may become more attractive.
Weekly US petroleum demand increased by 5.47% during the week ending February 6th. Domestic demand is up 3.06% vs. one-year ago and demand is currently 5.27% over the five year average.
Domestic production increased to a new all-time high on the week. The number of operating oil drilling rigs in the US continues to decline and the decline is accelerating. During the week, the number of operating rigs in the US declined by 84 or 7.37%. The previous week's decline was 83 rigs. This will limit production growth and may cause sustained declines in production which would help in balancing supply and demand in the market which would support price. The market has been watching this metric very closely and the sharp downturn in the number of operating rigs has contributed to the recent price increase. While this is true, production continues to increase and inventories continue to grow. The market is taking the steps to balance the supply and demand yet increasing production and growing inventories will keep prices low.
Below is the one-year chart of spot diesel futures prices as of February 13th.
Below is the one-year chart of spot gasoline futures prices as of February 13th.
: : Inventories increasing by 3.59 million barrels while inventories were expected to increase by 2.73 million barrels on the week. The five-year average inventory decreased by 1.23 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : The market continues to be oversupplied by about 1.5 to 2 million barrels per day. The market appears to have begun the process if solving this problem with lower rig counts indicating lower production levels in the future. However, the balancing of supply and demand may take many months and 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.
: : The China HSBC flash manufacturing purchasing managers' index rose unexpectedly showing some strength in the manufacturing sector in China. This is supportive of petroleum demand expectations and price.
: : Eurozone January Markit manufacturing purchasing managers' index also rose unexpectedly indicating some relative strength in the European economy which is positive for petroleum demand expectations and price.
: : Stock market increasing by +2.02% on the week is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreasing by 0.52% to a new eleven year high. This 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.
Below is the one-year chart US stock market prices as of February 13th.
Below is the one-year chart for the US dollar index as of February 13th.
During the week ended February 6th, total petroleum inventories increased by 3.59 million barrels vs. a five year average decrease of 1.23 million barrels and vs. an expected increase of 2.73 million barrels. Inventories increased by 4.82 million barrels vs. the five year average. Total inventories stand at 791.8 million barrels, up from 788.2 million barrels at the end of the previous week. The five year average inventory is 724.4 million barrels, down from 725.6 million barrels at the end of the previous week.
Current inventories are 9.30% higher than the five year average, up from +8.62% 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 February 10th, the net speculative long position in petroleum futures was 224,800,000 barrels down 5,937,000 barrels (-2.57%) from the previous week. Speculation decreased for the second week in a row and represents 28.39% of domestic inventories. Speculation decreased for the second week as prices increased by 10%. Speculation is 24.23% below its one year moving average. The corresponding spot month diesel futures price on February 10th was 183.27 cents per gallon, down 1.38 cents from 184.65 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 62.15% 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 38.63% 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 184.83 cents per gallon or 1.56 cents per gallon more than current prices. The analysis would indicate that about negative 0.85% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 3 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 297 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.