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Prices Lower - Speculation Lower - US Production Down - Inventory Down
During the week ending April 1st, the spot month diesel futures price decreased by 7.83 cents per gallon (-6.47%) while the deferred months decreased by 4 to 7 cent per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at an 18.55 cent premium to the spot price, from a premium of 17.97 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 decreased 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 April 1st, the spot month gasoline futures price decreased by 9.30 cents per gallon (+6.22%) while the deferred months decreased by 5 to 9 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 5.28 cent premium to the spot price, from a premium of 3.62 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 lower 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 lower on the week which is negative for price. US domestic crude production was lower which is positive for price. Domestic production is down 3.88% on a year over year basis.
Weekly US petroleum demand increased by 0.26% during the week ending March 25th. Domestic demand is up 2.20% vs. one-year ago and demand is currently 4.41% above the five year average.
Domestic production resumed its decline this week and is 3.88% below one year ago levels. The number of operating oil drilling rigs in the US continued to fall and stands at 362 which is 10 fewer than the previous week and 77.50% 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 and has decreased by 180,000 barrels per day since the beginning of the year.
Below is the one-year chart of spot diesel futures prices as of April 1st.
Below is the one-year chart of spot gasoline futures prices as of April 1st.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased by 1.29 million barrels while inventories were expected to increase by 0.25 million barrels on the week. The five-year average inventory increased by 1.53 million barrels. Inventories decreased vs. the five year average and vs. expectations.
: : The Federal Reserve signaled a more gradual rise in interest rates than was anticipated. This means a relatively weaker dollar which is positive for petroleum prices but also indicates a softer than expected economy, lower than expected petroleum demand and lower prices.
: : Stock market increasing by +1.72% on the week is generally positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreasing by -1.72% on the week 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.
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 April 1st.
Below is the one-year chart for the US dollar index as of April 1st.
During the week ended March 25th, total petroleum inventories decreased by 1.29 million barrels vs. a five year average increase of 1.53 million barrels and vs. an expected increase of 0.25 million barrels. Inventories decreased by 2.82 million barrels vs. the five year average and decreased by 1.49 million barrels vs. expectations. Total inventories stand at 938.6 million barrels, down from 939.9 million barrels at the end of the previous week. The five year average inventory is 741.4 million barrels, up from 739.8 million barrels at the end of the previous week.
Current inventories are 26.60% higher than the five year average, down from +27.04% at the end of the previous week.
As of March 29th, the net speculative long position in petroleum futures was 236,089,000 barrels, down 16,340,000 barrels (-6.47%) from the previous week. Speculation decreased for the first time in six weeks and represents 25.15% of domestic inventories. Speculation is 53.47% above its one year moving average. The corresponding spot month diesel futures price on March 29th was 115.55 cents per gallon, down 9.66 cents from 125.21 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 68.70% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 47.20% 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 154 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 29th, the market price for spot month diesel futures is estimated to be 129.32 versus the actual price of 115.55. This indicates that the market is currently undervalued by 13.77 cents per gallon given the assumptions of the pricing model.
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.