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Prices Lower - Dollar Higher - Speculation Higher - Production Higher - Higher Rig Count
During the week ending March 2nd, the spot month diesel futures price decreased by 9.30 cents per gallon (-4.71%) while the deferred months decreased by 5 to 9 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 2.27 cent discount to the spot price, from a discount of 2.78 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates lower 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 March 2nd, the spot month gasoline futures price decreased by 8.82 cents per gallon (-4.43%) while the deferred months decreased by 4 to 9 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 6.24 cent discount to the spot price, from a discount of 8.46 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 also includes speculation which was lower on the week.
Weekly US petroleum demand decreased by 2.84% during the week ending February 23rd. Domestic demand is up by 2.67% vs. one-year ago and demand is currently 6.69% above the five year average.
Weekly production remains above 10 million barrels per day.
Domestic production increased on the week and is 13.85% above year ago levels. The number of operating oil drilling rigs in the US was higher by 1 to 800 which is the highest level in nearly three years. Currently, this is 484 more than the recent low of 316 in 2016 and 50.28% lower than the peak of 1609 in October 2014. The 3 year 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 1,855,000 barrels per day (+22.01%) since the low on July 1, 2016. For perspective, OPEC production cuts in place since November 2016 is 1.8 million barrels per day – the same amount that US domestic production has grown during that time.
Below is the one-year chart of spot diesel futures prices as of March 2nd.
Below is the one-year chart of spot gasoline futures prices as of March 2nd.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories increased on the week by 4.54 million barrels while inventories were expected to increase by 1.60 million barrels on the week. The five-year average inventory increased by 4.19 million barrels. Inventories increased vs. the five year average and increased vs. expectations. Petroleum inventories including crude, gasoline, increased to a 19-week high.
: : Oilfield services costs are expected to rise by 10% over the next year which will increase the marginal cost of production of oil and support oil price in the long-term. Producers have been drilling wells but waiting to put them into production to take advantage of low drilling costs when prices were lower.
: : Libyan production has come back on-line after a short outage due to unrest. This is negative for price as there is more daily supply on the market.
: : The expectation of trade tariffs has caused equity markets to trade lower in a classic “risk off” fashion. Petroleum has participated in this sell-off to a certain extent. The expectation is also that any tariffs will result in slower global economic growth which is ultimately negative for petroleum demand growth and petroleum price.
: : The Stock market decreased by -2.04% which is negative for economic and petroleum demand expectations and prices. Equity market volatility and selling appeared to have affected petroleum markets driving prices lower.
: : The US Dollar increased by +0.06% 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.
OPEC Production Five Year History.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of March 2018. According to the chart, global supply and demand have essentially rebalanced. Starting in Q2 2018, there is an expectation of a surplus which is negative for price.
Below is the one-year chart US stock market prices as of March 2nd.
Below is the one-year chart for the US dollar index as of March 2nd.
During the week ended February 23rd, total petroleum inventories increased by 4.54 million barrels vs. a five year average increase of 4.19 million barrels and vs. an expected increase of 1.60 million barrels. Inventories increased by 0.35 million barrels vs. the five year average and increased by 2.94 million barrels vs. expectations. Total inventories stand at 813.3 million barrels, up from 808.8 million barrels at the end of the previous week. The five year average inventory is 799.2 million barrels, up from 795.0 million barrels at the end of the previous week.
Current inventories are 1.77% higher than the five year average, up from +1.73% at the end of the previous week.
As of February 27th, the net speculative long position in petroleum futures was 600,897,000 barrels, up 35,436,000 barrels (+6.27%) from the previous week. Speculation increased for the first time in four weeks and represents 73.88% of domestic inventories. Speculation is 59.24% above its one year moving average. The corresponding spot month diesel futures price on February 27th was 196.30 cents per gallon, up 3.53 cents from 192.77 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 91.97% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 84.59% 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 703 million barrels with an average of about 377 million barrels, which is up roughly 2 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 February 27th, the market price for spot month diesel futures is estimated to be 228.99 versus the actual price of 196.30. This indicates that the market is currently undervalued by 32.69 cents per gallon given the assumptions of the pricing model. Producer hedging appears to be keeping prices lower than they would ordinarily be.
Five Year History of Producer Hedging
Producer hedging and speculation have each grown by 500-600 million barrels since June suggesting that speculators are buying from hedgers with an expectation that speculators will unwind their trade and hedgers will not and will deliver oil instead. This is causing a surge in production and lower prices.
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.