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Three Year High Prices - Dollar Higher - Speculation Lower - Inventory Lower - Production Higher - Rig Count Steady
During the week ending May 18th, the spot month diesel futures price increased by 4.35 cents per gallon (+1.96%) while the deferred months increased by 4-6 cents per gallon making the forward pricing curve higher and less negatively sloped. The one year forward price ended the week at a 5.36 cent discount to the spot price, from a discount 6.21 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates higher current demand expectations and higher inventories with respect to demand. Demand also includes speculation which was lower 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 May 18th, the spot month gasoline futures price increased by 4.45 cents per gallon (+2.03%) while the deferred months changed by increased by 2-5 cents per gallon making the forward pricing curve higher and less negatively sloped. The one year forward price ended the week at a 7.30 cent discount to the spot price, from a discount of 8.51 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 higher inventory levels with respect to supply and demand. Demand also includes speculation which was lower on the week.
Weekly US petroleum demand decreased by 0.10% during the week ending May 11th. Domestic demand is up by 1.53% vs. one-year ago and demand is currently 1.44% above the five year average.
Domestic production increased on the week and is 15.24% above year ago levels. The number of operating oil drilling rigs in the US was unchanged at 844. Currently, this is 528 more than the low of 316 rigs in 2016 and 47.55% 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 2,295,000 barrels per day (+27.23%) 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 May 18th.
Below is the one-year chart of spot gasoline futures prices as of May 18th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories decreased on the week by 5.29 million barrels while inventories were expected to decrease by 5.07 million barrels on the week. The five-year average inventory decreased by 3.14 million barrels. Inventories decreased vs. the five year average and vs. expectations.
: : Iran sanctions are expected to take 700,000 barrels per day from global supply. The International Energy Agency expects that larger oil producers will step in and provide the supply that will be missing from Iran such that OPEC and Friends will be producing at target levels as a whole. If not, inventories will continue to deplete, price will continue to climb, and demand will decrease while US production surges. This would put OPEC in a position similar to where they were in 2014. OPEC is discussing raising output.
: : US sanctions on Venezuela could further limit that country’s already decreasing oil exports. This would mean more production off of the market and increasing the need for OPEC to step in with supply relief.
: : Demand growth estimates for 2018 were lowered by IEA to 1.4 million barrels per day year over year from 2017. This estimate was adjusted lower from 1.5 million barrels per day increase. By contrast, OPEC’s forecast is for an increase of 1.65 million barrels per day in 2018 over 2017.
: : The Stock market decreased by -0.54% had little effect on petroleum markets.
: : The US Dollar increased by +1.19% 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 May 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 increased slightly since the April 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 May 18th.
Below is the one-year chart for the US dollar index as of May 18th.
During the week ended May 11th, total petroleum inventories decreased by 5.29 million barrels vs. a five year average decrease of 4.14 million barrels and vs. an expected decrease of 5.07 million barrels. Inventories decreased by 2.18 million barrels vs. the five year average and decreased by 0.22 million barrels vs. expectations. Total inventories stand at 779.3 million barrels, down from 784.6 million barrels at the end of the previous week. The five year average inventory is 800.8 million barrels, down from 803.9 million barrels at the end of the previous week.
Current inventories are 2.68% lower than the five year average, down from -2.40% at the end of the previous week. Inventory remains below the five year average.
As of May 15th, the net speculative long position in petroleum futures was 595,815,000 barrels, down 5,721,000 barrels (-0.95%) from the previous week. Speculation decreased for the first time in three weeks and represents 76.45% of domestic inventories. Speculation is 35.61% above its one year moving average. The corresponding spot month diesel futures price on May 15th was 224.90 cents per gallon, up 9.13 cents from 215.77 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 93.59% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 87.58% of diesel fuel price movements are explained by changes in level of speculation. Higher levels of speculation typically cause higher correlation. Correlation continues to decrease.
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 439 million barrels, which is up roughly 8 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 May 15th, the market price for spot month diesel futures is estimated to be 224.02 versus the actual price of 224.90. This indicates that the market is currently overvalued by 0.88 cents per gallon given the assumptions of the pricing model.
Three Year History of Producer Hedging
Producer hedging and speculation have each grown by 400-600 million barrels since June 2017 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.