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Prices Steady - Speculation Spikes Up - US Production Down - Inventory Down
During the week ending March 18th, the spot month diesel futures price increased by 2.11 cents per gallon (+1.73%) while the deferred months increased by 1 to 2 cent per gallon making the forward pricing curve higher and less positively sloped. The one year forward price ended the week at a 15.48 cent premium to the spot price, from a premium of 16.51 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 inventories with respect to demand. Demand includes speculative demand which was significantly higher 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 18th, the spot month gasoline futures price decreased by 1.70 cents per gallon (-1.18%) while the deferred months increased by 0 to 2 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 6.58 cent premium to the spot price, from a premium of 5.48 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. Supply includes speculation which was higher on the week.
The US dollar was lower on the week which is positive for price. Inventories on the week were lower and lower than expected which is positive 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 lower which is positive for price. Domestic production is down 3.73% on a year over year basis.
Weekly US petroleum demand decreased by 3.04% during the week ending March 11th. Domestic demand is up 1.85% vs. one-year ago and demand is currently 4.40% above the five year average.
Domestic production resumed its decline this week and is 3.73% below one year ago levels. The number of operating oil drilling rigs in the US increased for the first time in 13 weeks by 1 rig to a total of 387 operating oil rigs in the US. A lower rig count is positive for price. The lower rig count has begun to cause US production to move downward as part of the global rebalancing of supply and demand. It is expected that US crude production will decrease by 500,000 barrels per day during 2016.
Below is the one-year chart of spot diesel futures prices as of March 18th.
Below is the one-year chart of spot gasoline futures prices as of March 18th.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased by 0.57 million barrels while inventories were expected to increase by 0.15 million barrels on the week. The five-year average inventory decreased by 0.09 million barrels. Inventories decreased vs. the five year average and decreased vs. expectations.
: : Talk of and scheduling of a meeting to discuss a production freeze among OPEC and non-OPEC nations has supported the market as it is believed that this action would curtail supply or at least be the first step in curtailing global supply. It may be all talk and might not matter anyway as supply disruptions and declines in Iran and Nigeria are causing global market supply to tighten slightly and probably temporarily. It is believed that Iran and Nigeria together are 800,000 barrels per day below where they should be in production. No word on how quickly this volume will return to the market.
: : Current prices that have recovered from the lows in January and February will give more incentive for producers who can increase production to do so which will further depress prices again.
: : Domestic inventory growth has slowed to zero in the past several weeks perhaps giving indication that inventories will not become larger. Steady to declining inventories are positive for price but again, higher prices will bring more supply to the market.
: : Another indication that market conditions are changing is that the number of operating oil rigs in the US has stopped declining at least for the time being. This translates into oil companies not ramping down investment any further which would be supportive of production levels and negative for price.
: : The EIA March forecast for global supply and demand of petroleum shows that the imbalance of supply and demand will be larger and last longer than thought a month ago. Will relatively high prices begin to bring more supply to the market and keep prices low and in a range? Time will tell but this is a likely scenario.
: : Stock market increasing by +1.35% on the week is generally positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreasing by 1.13% to a five month low is positive for petroleum price. This as a result of the Federal Reserve indicating that rate increases will be slower than previously expected. However, if other central banks continue to be extraordinarily accommodative in monetary policy, the dollar will appreciate anyway. 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.
The chart below shows supply and demand history and expectations. When supply and demand begin to rebalance, prices will increase from current levels. This forecast indicates that the market will be slower to balance than was thought in February indicating that prices are expected to be lower for longer.
Below is the one-year chart US stock market prices as of March 18th.
Below is the one-year chart for the US dollar index as of March 18th.
During the week ended March 11th, total petroleum inventories decreased by 0.57 million barrels vs. a five year average decrease of 0.09 million barrels and vs. an expected increase of 0.15 million barrels. Inventories decreased by 0.48 million barrels vs. the five year average and decreased by 0.72 million barrels vs. expectations. Total inventories stand at 934.2 million barrels, down from 934.8 million barrels at the end of the previous week. The five year average inventory is 737.8 million barrels, down from 737.9 million barrels at the end of the previous week.
Current inventories are 26.63% higher than the five year average, down from +26.69% at the end of the previous week.
Speculation has more than doubled in the past three weeks.
As of March 15th, the net speculative long position in petroleum futures was 219,554,000 barrels, up 36,502,000 barrels (+19.94%) from the previous week. Speculation increased for the fourth week in a row and represents 23.50% of domestic inventories. Speculation is 46.22% above its one year moving average. The corresponding spot month diesel futures price on March 15th was 117.77 cents per gallon, down 2.23 cents from 120.00 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 75.68% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 57.27% 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 57 million and 285 million barrels with an average of about 150 million barrels, which is roughly unchanged 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 March 15th, the market price for spot month diesel futures is estimated to be 128.75 versus the actual price of 117.77. This indicates that the market is currently undervalued by 9.98 cents per gallon given the assumptions of the pricing model.
The last time speculation was at these levels, prices were 70 cents higher on June 30, 2015.
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.