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Prices Mixed - Dollar Higher - Speculation Higher - Inventory Lower - Production Higher - Rig Count Lower
During the week ending March 30th, the spot month diesel futures price increased by 1.00 cent per gallon (+0.50%) while the deferred months decreased by 0 to 2 cents per gallon making the forward pricing curve generally lower and more negatively sloped. The one year forward price ended the week at a 4.33 cent discount to the spot price, from a discount 2.32 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates higher demand expectations and lower inventories with respect to demand. Demand also includes speculation which was 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 30th, the spot month gasoline futures price decreased by 1.57 cents per gallon (-0.77%) while the deferred months decreased by 1 to 2 cents per gallon making the forward pricing curve lower and more negatively sloped. The one year forward price ended the week at a 6.40 cent discount to the spot price, from a discount of 6.28 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. Demand also includes speculation which was higher on the week.
Weekly US petroleum demand increased by 1.17% during the week ending March 23rd. Domestic demand is up by 5.73% vs. one-year ago and demand is currently 9.02% above the five year average.
Domestic production increased on the week and is 14.06% above year ago levels. The number of operating oil drilling rigs in the US was lower by 7 to 797. Currently, this is 481 more than the recent low of 316 in 2016 and 50.46% lower than the peak of 1609 in October 2014. This 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 2,005,000 barrels per day (+23.79%) since the low on July 1, 2016. For perspective, OPEC production cuts in place since November 2016 is 1.8 million barrels per day – less than the amount that US domestic production has grown during that time.
Below is the one-year chart of spot diesel futures prices as of March 30th.
Below is the one-year chart of spot gasoline futures prices as of March 30th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories decreased on the week by 3.92 million barrels while inventories were expected to decrease by 3.96 million barrels on the week. The five-year average inventory decreased by 1.67 million barrels. Inventories decreased vs. the five year average and increased vs. expectations.
: : The likelihood that the Iran nuclear deal will be revised which may bring back sanctions on Iran including curtailing their oil exports continues to sustain geopolitical risk as sanction-era Iranian production was 1 million barrels per day lower than current production. Taking 1 million barrels per day off of the global market would cause a deficit that may or may not be made up by Saudi Arabia and other producers including American shale producers. The removal of the Iran nuclear deal would be positive for price.
: : Venezuela’s production fell another 100,000 barrels per day in March (-6.21%) and is down 24.5% over the past year. It appears that Venezuela’s production will continue to decline as a result of lack of investment caused by that country’s political turmoil.
: : OPEC is talking about keeping the supply cuts longer than expected into 2019. The non-OPEC members of the coalition are indicating that cooperation with OPEC may be a permanent arrangement. This is supportive of price. As OPEC and Friends keeps their output cuts in place, US shale production will continue to grow to meet global demand growth. This will diminish OPEC’s market share. Will this play out like it did in 2014? Will OPEC eventually want market share back? Time will tell the results of the Shale vs. OPEC battle.
: : The Stock market increased by +2.03% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increased by +0.60% 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 – Down 170,000 barrels per day from February to March.
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 30th.
Below is the one-year chart for the US dollar index as of March 30th.
During the week ended March 23rd, total petroleum inventories decreased by 3.92 million barrels vs. a five year average decrease of 1.67 million barrels and vs. an expected decrease of 3.96 million barrels. Inventories decreased by 2.25 million barrels vs. the five year average and increased by 0.04 million barrels vs. expectations. Total inventories stand at 798.5 million barrels, down from 802.4 million barrels at the end of the previous week. The five year average inventory is 799.8 million barrels, down from 801.5 million barrels at the end of the previous week.
Current inventories are 0.17% lower than the five year average, down from +0.11% at the end of the previous week. This is the first time since December 2014 that inventory has been below the five year average.
As of March 27th, the net speculative long position in petroleum futures was 613,981,000 barrels, up 22,005,000 barrels (+3.72%) from the previous week. Speculation increased for the second week and represents 76.89% of domestic inventories. Speculation is 55.21% above its one year moving average. The corresponding spot month diesel futures price on March 27th was 201.48 cents per gallon, up 6.53 cents from 194.95 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 94.33% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 88.98% of diesel fuel price movements are explained by changes in level of speculation. Higher levels of speculation typically cause higher correlation.
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 396 million barrels, which is up roughly 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 March 27th, the market price for spot month diesel futures is estimated to be 231.66 versus the actual price of 202.24. This indicates that the market is currently undervalued by 29.42 cents per gallon given the assumptions of the pricing model. Producer hedging appears to be keeping prices lower than they would ordinarily be.
Three Year History of Producer Hedging
Producer hedging and speculation have each grown by 400-600 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.