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Iran Agreement - Prices Higher - Dollar Higher - Speculation Higher - Inventory Higher - Production Higher - Rig Count Higher
During the week ending April 27th, the spot month diesel futures price increased by 2.79 cents per gallon (+1.31%) while the deferred months changed by +2 to -2 cents per gallon making the forward pricing curve more negatively sloped. The one year forward price ended the week at an 8.35 cent discount to the spot price, from a discount 6.24 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates higher current 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 April 27th, the spot month gasoline futures price increased by 3.10 cents per gallon (+1.48%) while the deferred months changed by increased by -1 to +3 cents per gallon making the forward pricing curve negatively sloped. The one year forward price ended the week at a 9.86 cent discount to the spot price, from a discount of 7.46 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates higher current 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 decreased by 11.36% during the week ending April 20th. Domestic demand is up by 4.26% vs. one-year ago and demand is currently 7.48% above the five year average.
Domestic production increased on the week and is 14.25% above year ago levels. The number of operating oil drilling rigs in the US was higher by 5 to 825. Currently, this is 509 more than the low of 316 rigs in 2016 and 48.73% 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 2,158,000 barrels per day (+25.61%) since the low on July 1, 2016. For perspective, OPEC decreases in production since November 2016 amount to 2,100,000 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 April 27th.
Below is the one-year chart of spot gasoline futures prices as of April 27th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories increased on the week by 0.40 million barrels while inventories were expected to decrease by 4.00 million barrels on the week. The five-year average inventory increased by 3.68 million barrels. Inventories decreased vs. the five year average and increased vs. expectations.
: : All eyes are on Iran and whether the US will exit the Iran nuclear agreement. If the US does exit, it is assumed that sanctions will resume which would potentially remove 1 million barrels from the global oil market. This deficit would need to be made up by other producers. If not, the market would continue to tighten and prices would continue to rise.
: : The Stock market decreased by -0.01% had little effect on petroleum markets.
: : The US Dollar increased by +1.36% 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 April 2018. According to the chart, global supply has been about 500,000 barrels per day less than consumption for the past year which has caused global inventories to decrease to near five year average levels. The surplus expected for the remainder of 2018 and 2019 has decreased slightly since the March forecast. An expected surplus moving forward is negative for price but the slow tightening of the oil market is positive for price.
Below is the one-year chart US stock market prices as of April 27th.
Below is the one-year chart for the US dollar index as of April 27th.
During the week ended April 20th, total petroleum inventories increased by 0.40 million barrels vs. a five year average increase of 3.68 million barrels and vs. an expected decrease of 4.00 million barrels. Inventories decreased by 3.28 million barrels vs. the five year average and increased by 4.41 million barrels vs. expectations. Total inventories stand at 789.3 million barrels, up from 788.9 million barrels at the end of the previous week. The five year average inventory is 807.2 million barrels, up from 803.5 million barrels at the end of the previous week.
Current inventories are 2.22% lower than the five year average, down from -1.83% at the end of the previous week. Inventory remains below the five year average.
As of April 24th, the net speculative long position in petroleum futures was 613,764,000 barrels, up 11,512,000 barrels (+1.91%) from the previous week. Speculation increased for the second week and represents 77.76% of domestic inventories. Speculation is 48.24% above its one year moving average. The corresponding spot month diesel futures price on April 24th was 212.76 cents per gallon, up 7.05 cents from 205.71 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 95.11% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 90.45% 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 414 million barrels, which is up roughly 5 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 April 24th, the market price for spot month diesel futures is estimated to be 226.91 versus the actual price of 212.76. This indicates that the market is currently undervalued by 14.15 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.
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.