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Prices Mixed - Speculation Spikes Again - US Production Down - Inventory Up
During the week ending March 25th, the spot month diesel futures price decreased by 4.12 cents per gallon (-3.32%) while the deferred months decreased by 1 to 4 cent per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 17.97 cent premium to the spot price, from a premium of 15.48 cents at the end of the previous week.
The change in level and slope of the diesel forward pricing curve indicates lower demand expectations and higher 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 25th, the spot month gasoline futures price increased by 3.86 cents per gallon (+2.70%) while the deferred months increased by 1 to 3 cents per gallon making the forward pricing curve higher and less positively sloped. The one year forward price ended the week at a 3.62 cent premium to the spot price, from a premium of 6.58 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. Supply includes speculation which was higher on the week.
The US dollar was higher on the week which is negative for price. Inventories on the week were higher and higher than expected which is negative for price. The stock market, as a proxy for demand expectations, was lower which is negative 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 4.08% on a year over year basis.
Weekly US petroleum demand increased by 0.74% during the week ending March 18th. Domestic demand is up 1.63% vs. one-year ago and demand is currently 5.94% above the five year average.
Domestic production resumed its decline this week and is 4.08% below one year ago levels. The number of operating oil drilling rigs in the US continued to fall and stands at 372 which is 15 fewer than the previous week and 76.88% lower than the peak in October 2014. 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 25th.
Below is the one-year chart of spot gasoline futures prices as of March 25th.
MARKET FACTORS & COMMENTARY:
: : Inventories increased by 5.63 million barrels while inventories were expected to decrease by 0.40 million barrels on the week. The five-year average inventory increased by 2.03 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : Speculators brought the market higher during the week but concerns of global economic growth slowing and larger than expected inventories caused prices to weaken at the end of the week. The dollar is at a relative low. If the dollar strengthens as many expect it to, petroleum prices will fall.
: : 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 decreasing by -0.67% on the week is generally negative for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by 1.25% 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.
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 25th.
Below is the one-year chart for the US dollar index as of March 25th.
During the week ended March 18th, total petroleum inventories increased by 5.63 million barrels vs. a five year average increase of 2.03 million barrels and vs. an expected decrease of 0.40 million barrels. Inventories increased by 3.60 million barrels vs. the five year average and increased by 6.03 million barrels vs. expectations. Total inventories stand at 939.9 million barrels, up from 934.2 million barrels at the end of the previous week. The five year average inventory is 739.8 million barrels, up from 737.8 million barrels at the end of the previous week.
Current inventories are 27.04% higher than the five year average, up from +26.63% at the end of the previous week.
Speculation surged to its highest level since June 23rd.
As of March 22nd, the net speculative long position in petroleum futures was 252,429,000 barrels, up 32,875,000 barrels (+14.97%) from the previous week. Speculation increased for the fifth week in a row and represents 26.86% of domestic inventories. Speculation is 65.63% above its one year moving average. The corresponding spot month diesel futures price on March 22nd was 125.21 cents per gallon, up 7.44 cents from 117.77 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 72.37% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 52.38% 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 152 million barrels, which is up about 2 million 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 22nd, the market price for spot month diesel futures is estimated to be 128.01 versus the actual price of 125.21. This indicates that the market is currently undervalued by 2.80 cents per gallon given the assumptions of the pricing model.
The last time speculation was at these levels on June 23rd, prices were at 191.12 for diesel - 65.91 cents higher than current 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.