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Prices Higher - Inventory Up - Rig Count Down - Dollar Down - Spec Up
During the week ending April 24th, the spot month diesel futures price increased by 4.59 cents per gallon (+2.44%) while the deferred months increased by 4 to 5 cents per gallon making the forward pricing curve higher and unchanged in sloped. The one year forward price ended the week at a 9.29 cent premium to the spot price, from a premium of 9.62 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 steady supplies with respect to demand. Demand includes speculative demand 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 April 24th, the spot month gasoline futures price increased by 7.80 cents per gallon (+4.04%) while the deferred months increased from 2 to 4 cents per gallon making the forward pricing curve higher and relatively steady in slope. The one year forward price ended the week at a 3.26 cent discount to the spot price, from a premium of 0.09 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.
The US dollar decreased on the week which is positive for price. Inventories on the week were higher 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 on the week which is positive for price. Domestic production is up 11.67% year over year - the slowest year over year pace since September 5th.
The attractiveness of making new hedges decreased due to higher prices and higher levels of speculation. On a flat-price basis, prices remain relatively attractive when compared to the last four years and are above the middle of where prices have been over the past four months. The market has found a price range. Speculation was higher giving the hedger more competition with speculators for long positions. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging may become more attractive.
Weekly US petroleum demand increased by 0.76% during the week ending April 17th. Domestic demand is up 5.18% vs. one-year ago and demand is currently 2.82% over the five year average.
Domestic production decreased slightly on the week. The number of operating oil drilling rigs in the US continues to decline. During the week, the number of operating rigs in the US declined by 31 or 4.22%. The previous week's decline was 26 rigs. This will limit production growth and may cause sustained declines in production which would help in balancing supply and demand in the market which would support price. The market has been watching this metric very closely and the sharp downturn in the number of operating rigs has contributed to the recent price increase. While this is true, inventories continue to grow. The market is taking the steps to balance the supply and demand yet increasing production and growing inventories will keep prices relatively low. As the rate of change in production and inventory growth decreases, the market will take this as a signal to buy and prices will continue to firm up.
Many new wells are being drilled but not yet finished, fracked, and put into production. When prices rise, these wells could be put into production relatively quickly in response to higher prices and higher demand. This "fracklog" as it has been dubbed, will act as inventory being stored in the ground and will serve as a cap on prices in the short to medium-term. The question is at what price this will be triggered.
Below is the one-year chart of spot diesel futures prices as of April 24th.
Below is the one-year chart of spot gasoline futures prices as of April 24th.
: : Inventories increasing by 3.58 million barrels while inventories were expected to increase by 3.08 million barrels on the week. The five-year average inventory increased by 1.03 million barrels. Inventories increased vs. the five year average and vs. expectations. While inventories are large, their rate of growth is slowing and becoming more in line with expectations. This slowing in growth rate of inventories will stabilize and support price. The overall level of inventories will keep prices relatively low in the short to medium-term.
: : The market continues to be oversupplied and is correcting the over-supply. The process of balancing supply is seen in lower rig count in the US and higher global demand expectations due to lower price. While these things have begun, US Domestic production is expected to continue to grow but at a slower pace, and inventories continue to become larger at a slower pace. Any significant increase in price would cause a resumption of production growth and would curtail any growth in demand thus limiting rapid upward price movements.
: : Speculation increased to its highest level since early August when prices began to weaken on disappearing fears that storage facilities in the US would be filled to capacity which would be negative for price. Speculation is also increasing due to the general beginning of market rebalancing of supply and demand which makes the likelihood of significantly lower prices lower. Will producers begin to produce more at these higher prices? If so, then speculators will exit and prices will fall.
: : Prices were again supported this past week as Saudi resumed its bombing of Shiite rebels in Yemen. The fear here is that the situation could escalate to the point where there is actual supply disruption either due to any damage to oil infrastructure or hostilities taking place in places where oil is transported including the Straits of Hormuz and the Gulf of Aden just south of Yemen.
: : Stock market increasing by +1.75% on the week is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreasing by -0.61% 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.
Below is the one-year chart US stock market prices as of April 24th.
Below is the one-year chart for the US dollar index as of April 24th.
During the week ended April 17th, total petroleum inventories increased by 3.58 million barrels vs. a five year average increase of 1.03 million barrels and vs. an expected increase of 3.08 million barrels. Inventories increased by 2.54 million barrels vs. the five year average. Total inventories stand at 844.1 million barrels, up from 840.5 million barrels at the end of the previous week. The five year average inventory is 720.2 million barrels, up from 719.2 million barrels at the end of the previous week.
Current inventories are 17.20% higher than the five year average, up from +16.87% at the end of the previous week. Inventory levels are growing due to excess supply and low price where those who hold inventories are accumulating more which is essentially increasing a speculative long position in the market. Those who hold inventories have an incentive to do so since forward prices are higher than spot prices, holders of inventory can earn an attractive guaranteed return on their investment.
As of April 21st, the net speculative long position in petroleum futures was 271,666,000 barrels up 46,688,000 barrels (+20.75%) from the previous week. Speculation has doubled over the past four weeks. Speculation increased for the fourth week in a row and represents 32.19% of domestic inventories. Speculation is 6.35% above its one year moving average. This is the first reading of speculation above the one year moving average since July 8, 2014. The corresponding spot month diesel futures price on April 21st was 185.32 cents per gallon, up 5.15 cents from 180.17 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 57.74% correlated over the past 52 weeks indicating that, on a statistical basis over the past year 33.33% of the price movement of diesel fuel is explained by changes in levels of speculation. A linear regression analysis over the past 52 weeks shows that if speculation were zero and the market forces causing speculation evaporated, that the spot month diesel futures price would be 163.06 cents per gallon or 22.26 cents per gallon less than current prices. The analysis would indicate that about 12.01% of current price is attributable to speculation and its underlying market rationale. This "would be" price was lower by less than 1 cent on the week.
The net speculative long position has been variable over the past year ranging between 135 million and 453 million barrels with an average of about 255 million barrels, which is down about 4 million barrels on the week.
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.