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Prices Higher - Speculation Higher - US Production Down - Inventory Up
During the week ending April 15th, the spot month diesel futures price increased by 3.18 cents per gallon (+2.65%) while the deferred months changed by -1 to +3 cent per gallon making the forward pricing curve steady and less positively sloped. The one year forward price ended the week at a 15.07 cent premium to the spot price, from a premium of 16.50 cents at the end of the previous week.
The change in level and slope of the diesel forward pricing curve indicates steady demand expectations and lower inventories with respect to demand. Demand includes speculative demand which increased 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 15th, the spot month gasoline futures price decreased by 0.25 cents per gallon (-.017%) while the deferred months increased by 0 to 3 cents per gallon making the forward pricing curve mostly higher and more positively sloped. The one year forward price ended the week at a 6.16 cent premium to the spot price, from a premium of 4.01 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 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 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 4.34% on a year over year basis.
Weekly US petroleum demand increased by 0.60% during the week ending April 8th. Domestic demand is up 3.17% vs. one-year ago and demand is currently 4.90% above the five year average.
Domestic production resumed its decline this week and is 4.34% below one year ago levels. The number of operating oil drilling rigs in the US continued to fall and stands at 351 which is 3 fewer than the previous week and 78.19% lower than the peak in October 2014. A lower rig count is positive for price. The lower rig count is causing 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 470,000 barrels per day during 2016 to around 8.5 million barrels per day. US domestic production has decreased by 242,000 barrels per day since the beginning of the year.
Below is the one-year chart of spot diesel futures prices as of April 15th.
Below is the one-year chart of spot gasoline futures prices as of April 15th.
MARKET FACTORS & COMMENTARY:
: : Inventories increased by 2.90 million barrels while inventories were expected to decrease by 0.50 million barrels on the week. The five-year average inventory increased by 0.24 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : The market anticipated the meeting in Doha Qatar on the 17th where some of the world's oil producing countries were to meet to discuss a "freeze" in the level of production for each country. The meeting was over before it began as Saudi Arabia announced that it would make no agreements if Iran were not included and would make the same agreement. Iran is in the process of increasing its production in the wake of the sanctions which kept their oil off of the market. No deal was reached in Doha. Speculation surrounding the outcome of this meeting kept prices elevated.
: : OPEC is forecasting weaker than expected demand for petroleum globally due to warm weather and slowing expansion in emerging market economies. This is negative for prices.
: : The International Energy Agency (IEA) is predicting that supply and demand will move back to near balance in the second half of 2016 from a current daily surplus of 1.5 million barrels to a surplus of 200,000 barrels per day. This would certainly boost price as demand would outpace supply on a relative basis.
: : Stock market increasing by +1.62% on the week is generally positive for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by +0.49% 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 15th.
Below is the one-year chart for the US dollar index as of April 15th.
During the week ended April 8th, total petroleum inventories increased by 2.90 million barrels vs. a five year average increase of 0.24 million barrels and vs. an expected decrease of 0.50 million barrels. Inventories increased by 2.66 million barrels vs. the five year average and increased by 3.36 million barrels vs. expectations. Total inventories stand at 939.8 million barrels, up from 936.9 million barrels at the end of the previous week. The five year average inventory is 741.4 million barrels, up from 741.1 million barrels at the end of the previous week.
Current inventories are 26.77% higher than the five year average, up from +26.41% at the end of the previous week.
As of April 12th, the net speculative long position in petroleum futures was 227,208,000 barrels, up 31.948,000 barrels (+16.36%) from the previous week. Speculation increased for the first time in three weeks and represents 24.18% of domestic inventories. Speculation is 47.85% above its one year moving average. The corresponding spot month diesel futures price on April 12th was 127.59 cents per gallon, up 20.13 cents from 107.46 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 63.09% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 39.80% 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 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 April 15th, the market price for spot month diesel futures is estimated to be 125.87 versus the actual price of 123.22. This indicates that the market is currently undervalued by 2.65 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.