Inventories Up - Prices Down - Rig Count Up - Production Down
During the week ending June 9th, the spot month diesel futures price decreased by 5.36 cents per gallon (-3.61%) while the deferred months decreased by 2 to 6 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 7.81 cent premium to the spot price, from a premium of 6.19 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates lower demand expectations and higher inventories with respect to demand. Demand includes speculative demand which decreased 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 12th, the spot month gasoline futures price decreased by 7.54 cents per gallon (-4.78%) while the deferred months decreased by 0 to 5 cents per gallon making the forward pricing curve lower with a generally higher slope. The one year forward price ended the week at a 5.07 cent premium to the spot price, from a premium of 0.21 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. Demand includes speculative demand 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 which is negative for price. The stock market, as a proxy for demand expectations, was lower which is negative for price. Speculation was lower on the week which is negative for price. US domestic crude production was lower which positive for price. Domestic production is now positive year over year and is up 6.55% on a year over year basis. Oil rig count indicating the number of oil wells currently being developed by drilling was up on the week which is negative for price.
Weekly US petroleum demand decreased by 6.83% during the week ending June 2nd. Domestic demand is down by 1.19% vs. one-year ago and demand is currently 5.59% above the five year average.
Domestic production decreased for the first time in three weeks and is 6.55% above year ago levels. The number of operating oil drilling rigs in the US increased by 8 and stands at 741. This is 425 more than the recent low of 316 and 53.95% lower than the peak of 1609 in October 2014. The increasing rig count is causing US production to stabilize and grow as the global rebalancing of supply and demand continues. US domestic production has increased by 890,000 barrels per day (+10.56%) since the recent low on July 1, 2016 and has decreased by 292,000 barrels per day (-3.04%) since the peak of 9.61 million barrels per day in June 2015.
Below is the one-year chart of spot diesel futures prices as of June 9th.
Below is the one-year chart of spot gasoline futures prices as of June 9th.
MARKET FACTORS & COMMENTARY:
: : Inventories increased by 10.97 million barrels while inventories were expected to decrease by 3.26 million barrels on the week. The five-year average inventory decreased by 1.13 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : A surprise increase in US inventories (the largest weekly increase in nearly ten years) put downward pressure on price as it becomes increasingly apparent that OPEC's efforts will most likely not be as successful as they would like them to be. The surplus in supply is now expected to persist through the end of 2017. This will keep prices low for the short-term.
: : A scenario that is being discussed is that shale production will not keep up with demand in the long-term and more investment will need to be made in traditional oil production. Should this happen where the majority of investment is in shale and there is under-investment in traditional resources, demand may outstrip supply in the coming years which would cause prices to rise for a period and also increase the pricing power of OPEC. What remains to be seen is whether shale production can increase indefinitely and support global demand growth. If it can't at current price levels, prices will rise and traditional production would have a stronger hand in market pricing.
: : The Stock market decreased by -0.30% which is negative for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by +0.58% 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.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of June 2017. Supply and demand are in the process of re-balancing which is the main cause of steady price levels over the past 9 months. This forecast shows a relatively balanced market for 2017 and 2018 which generally indicates firmer and volatile prices moving forward. There will need to be a period of deficit in order to deplete the inventories that have accumulated over the past several years. This will then return the market to more normal conditions and higher prices.
Below is the one-year chart US stock market prices as of June 9th.
Below is the one-year chart for the US dollar index as of June 9th.
During the week ended June 2nd, total petroleum inventories decreased by 10.97 million barrels vs. a five year average decrease of 1.13 million barrels and vs. an expected decrease of 3.26 million barrels. Inventories increased by 12.10 million barrels vs. the five year average and decreased by 14.24 million barrels vs. expectations. Total inventories stand at 904.6 million barrels, up from 893.7 million barrels at the end of the previous week. The five year average inventory is 751.8 million barrels, down from 752.9 million barrels at the end of the previous week.
Current inventories are 20.33% higher than the five year average, up from +18.69% at the end of the previous week.
As of June 6th, the net speculative long position in petroleum futures was 219,765,000 barrels, down 7,097,000 barrels (-3.13%) from the previous week. Speculation decreased for the first time in four weeks and represents 24.29% of domestic inventories. Speculation is 23.03% below its one year moving average. The corresponding spot month diesel futures price on June 6th was 146.62 cents per gallon, down 8.32 cents from 154.94 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 86.31% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 74.49% 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 89 million and 488 million barrels with an average of about 286 million barrels, which is down about 2 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 June 6th, the market price for spot month diesel futures is estimated to be 141.56 versus the actual price of 146.62. This indicates that the market is currently overvalued by 5.06 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.