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Prices Down - Inventory Up - Rig Count Lower - Dollar Down - Production Up
During the week ending June 5th, the spot month diesel futures price decreased by 8.01 cents per gallon (-4.11%) while the deferred months decreased by 4 to 8 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 9.82 cent premium to the spot price, from a premium of 5.67 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 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 June 5th, the spot month gasoline futures price decreased by 3.27 cents per gallon (-1.59%) while the deferred months decreased from 2 to 4 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 10.65 cent discount to the spot price, from a discount of 12.25 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.
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 lower which is negative for price. Speculation was higher on the week which is positive for price. US domestic crude production was higher on the week to a new all-time high which is negative for price. Domestic production is up 14.35% year over year.
The attractiveness of making new hedges improved with the lower price environment while slightly higher speculation made new hedges less attractive.
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 decreased by 5.52% during the week ending May 29th. Domestic demand is up 4.31% vs. one-year ago and demand is currently 5.10% over the five year average.
Domestic production surged to a new all-time high for the second week showing that despite the lower rig count and lower prices, domestic production continues to grow. 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 4 or 0.62%. The previous week's decline was 13 rigs. This will limit production growth and is beginning to show stabilization and decline in production which is helping to balance 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.
Oil producers are learning how to cut costs and are getting better and finding oil more cheaply which brings down the marginal cost of production that, in turn, acts as a cap on oil prices. Also, the ability to quickly increase production in response to higher prices is improving. If supply can quickly respond to price, this increases the price elasticity of supply which would be a sea change in the fundamentals of the global oil market. Production that can quickly respond to price acts more like inventory than it does production. US domestic production and rig count will become increasingly more important to the market. Inventory is also very important as has always been true. But just because US domestic inventories are decreasing from their peaks, doesn't mean that there isn't more oil coming out of the ground globally than is going up in smoke on a daily basis which ultimately weighs on price.
Below is the one-year chart of spot diesel futures prices as of June 5th.
Below is the one-year chart of spot gasoline futures prices as of June 5th.
: : Inventories continue to decrease from the recent high levels set on April 24th. Inventories increased by 1.49 million barrels while inventories were expected to decrease by 0.79 million barrels on the week. The five-year average inventory decreased by 0.03 million barrels. Inventories increased vs. the five year average and vs. expectations. The global market continues to be oversupplied by 1.5 to 2.0 million barrels per day which will keep downward pressure on prices.
: : Stock market decreasing by -0.69% on the week is generally negative for economic and petroleum demand expectations and prices.
: : The US Dollar decreasing by -0.62% 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 June 5th.
Below is the one-year chart for the US dollar index as of June 5th.
During the week ended May 29th, total petroleum inventories increased by 1.49 million barrels vs. a five year average decrease of 0.03 million barrels and vs. an expected decrease of 0.79 million barrels. Inventories increased by 1.81 million barrels vs. the five year average. Total inventories stand at 830.3 million barrels, up from 828.8 million barrels at the end of the previous week. The five year average inventory is 724.11 million barrels, down from 724.42 million barrels at the end of the previous week.
Current inventories are 14.67% higher than the five year average, up from +14.41% at the end of the previous week.
As of June 2nd, the net speculative long position in petroleum futures was 266,128,000 barrels, up 2,260,000 barrels (+0.86%) from the previous week. Speculation increased for the second week in a row and represents 32.05% of domestic inventories. Speculation is 11.60% above its one year moving average. The corresponding spot month diesel futures price on June 2nd was 194.55 cents per gallon, up 4.53 cents from 190.02 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 39.95% correlated over the past 52 weeks indicating that, on a statistical basis over the past year 15.96% 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 168.62 cents per gallon or 25.93 cents per gallon less than current prices. The analysis would indicate that about 13.33% of current price is attributable to speculation and its underlying market rationale. This "would be" price was higher by slightly more 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 238 million barrels, which is down about 3 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.