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Prices Down - Inventory Plummets - Production Up - Speculation Up
During the week ending July 7th, the spot month diesel futures price decreased by 3.49 cents per gallon (-2.35%) while the deferred months decreased by 2 to 4 cents per gallon making the forward pricing curve lower and relatively unchanged in slope. The one year forward price ended the week at a 5.75 cent premium to the spot price, from a premium of 6.32 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates lower demand expectations and steady inventories with respect to demand. Demand includes speculative demand which increased 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 July 7th, the spot month gasoline futures price decreased by 1.53 cents per gallon (-1.01%) while the deferred months decreased by 2 to 4 cents per gallon making the forward pricing curve lower and generally unchanged in slope. The one year forward price ended the week at a 3.15 cent premium to the spot price, from a premium of 6.17 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and steady inventory levels with respect to supply and demand. Demand includes speculative demand which was higher on the week.
The US dollar was higher on the week which is negative for price. Inventories on the week were lower which is positive 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 higher which is negative for price. Domestic production is up 10.80% 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 increased by 13.13% during the week ending June 30th. Domestic demand is up by 0.49% vs. one-year ago and demand is currently 4.40% above the five year average.
Domestic production increased for the second week and is 10.80% above year ago levels. The number of operating oil drilling rigs in the US increased by 7 and stands at 763. This is 447 more than the recent low of 316 and 52.58% lower than the peak of 1609 in October 2014. The increasing rig count is causing US production to grow as the global rebalancing of supply and demand continues. US domestic production has increased by 910,000 barrels per day (+10.80%) since the recent low on July 1, 2016 and has decreased by 272,000 barrels per day (-2.83%) 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 July 7th.
Below is the one-year chart of spot gasoline futures prices as of July 7th.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased by 11.82 million barrels while inventories were expected to decrease by 3.47 million barrels on the week. The five-year average inventory decreased by 2.10 million barrels. Inventories decreased vs. the five year average and vs. expectations.
: : Libya, the OPEC country along with Nigeria that is exempt from current OPEC production cuts, increased its production to a four year high of just over 1 million barrels per day up from about 800,000 bpd - an increase of about 200,000 barrels per day in a short period of time. This, of course, weighs on the market as it increases supply, and further stymies OPEC & Friends' efforts to rebalance the market and support price. This is negative for price.
: : Russia, one of the oil exporting countries that has agreed to act in concert with OPEC, has indicated that it opposes further supply cuts in an effort to balance the market and stabilize prices. Of course, this is negative for price as it indicates the lower likelihood of decreases in supply in the future from the OPEC & Friends group.
: : The Stock market increased by +0.07% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by +0.40% 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 July 7th.
Below is the one-year chart for the US dollar index as of July 7th.
During the week ended June 30th, total petroleum inventories decreased by 11.82 million barrels vs. a five year average decrease of 2.10 million barrels and vs. an expected decrease of 3.47 million barrels. Inventories decreased by 9.72 million barrels vs. the five year average and decreased by 8.34 million barrels vs. expectations. Total inventories stand at 890.6 million barrels, down from 902.5 million barrels at the end of the previous week. The five year average inventory is 745.7 million barrels, down from 747.8 million barrels at the end of the previous week.
Current inventories are 19.43% higher than the five year average, down from +20.68% at the end of the previous week.
As of July 4th, the net speculative long position in petroleum futures was 119,027,000 barrels, up 37,862,000 barrels (+46.65%) from the previous week. Speculation increased for the first time in five weeks and represents 13.36% of domestic inventories. Speculation is 57.18% below its one year moving average. The corresponding spot month diesel futures price on July 4th was 147.85 cents per gallon, up 6.48 cents from 141.37 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 86.27% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 74.43% 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 81 million and 488 million barrels with an average of about 278 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 July 4th, the market price for spot month diesel futures is estimated to be 127.43 versus the actual price of 147.85. This indicates that the market is currently overvalued by 20.42 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.