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Prices Down - Rig Count Higher - Speculation Plummets
During the week ending July 10th, the spot month diesel futures price decreased by 10.00 cents per gallon (-5.44%) while the deferred months decreased by 4 to 10 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 12.10 cent premium to the spot price, from a premium of 9.85 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 sharply 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 July 10th, the spot month gasoline futures price decreased by 1.78 cents per gallon (-0.87%) while the deferred months decreased by 5 and 8 cents per gallon making the forward pricing curve lower and more negatively sloped. The one year forward price ended the week at a 21.09 cent discount to the spot price, from a discount of 16.16 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and lower 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 virtually unchanged which is neutral for price. Speculation was sharply lower on the week which is negative for price. US domestic crude production was higher which is negative for price. Domestic production is up 12.80% year over year.
The attractiveness of making new hedges increased with the lower price environment and sharply lower speculation.
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 2.45% during the week ending July 3rd. Domestic demand is up 4.71% vs. one-year ago and demand is currently 2.74% over the five year average.
Domestic production increased on the week to near record levels. The number of operating oil drilling rigs in the US increased for the second week indicating that perhaps the long decline in domestic drilling activity is over and that drilling new wells is economically viable. This is negative for price. Rig count increased by 5 and the previous week's increase was 12. This increase in rig count is a significant factor in lower speculation.
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.
OPEC production is up over 1 million barrels in the past three months and the imbalance in supply and demand is expected to last longer that was first thought. This will keep prices low for the short to medium-term. As global demand grows to meet supply and the market becomes balanced, prices will increase. If demand does not grow as quickly as expected, prices will fall to curtail supply.
Below is the one-year chart of spot diesel futures prices as of July 10th.
Below is the one-year chart of spot gasoline futures prices as of July 10th.
: : Inventories increased by 3.24 million barrels while inventories were expected to increase by 0.23 million barrels on the week. The five-year average inventory decreased by 2.28 million barrels. Inventories increased vs. the five year average and vs. expectations. The global market continues to be oversupplied by 1.5 to 2.5 million barrels per day which will keep downward pressure on prices.
: : Stock market decreasing by -0.01% on the week is generally negative for economic and petroleum demand expectations and prices.
: : The US Dollar decreasing by -0.09% 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 July 10th.
Below is the one-year chart for the US dollar index as of July 10th.
During the week ended July 3rd, total petroleum inventories increased by 3.24 million barrels vs. a five year average decrease of 2.28 million barrels and vs. an expected increase of 0.22 million barrels. Inventories increased by 5.52 million barrels vs. the five year average. Total inventories stand at 821.2 million barrels, up from 817.9 million barrels at the end of the previous week. The five year average inventory is 718.6 million barrels, down from 720.9 million barrels at the end of the previous week.
Current inventories are 14.27% higher than the five year average, up from +13.46% at the end of the previous week.
As of July 7th, the net speculative long position in petroleum futures was 164,130,000 barrels, down 64,344,000 barrels (-28.16%) from the previous week. Speculation decreased for the third week in a row and represents 19.99% of domestic inventories. Speculation is 25.22% below its one year moving average. The corresponding spot month diesel futures price on July 7th was 171.13 cents per gallon, down 17.53 cents from 188.66 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are -1.6% correlated over the past 52 weeks indicating that, on a statistical basis over the past year speculation does not explain price. As we have seen the market overwhelmed by supply, petroleum market fundamentals have taken the role of setting price and speculators are less able to move price. With the current over supply situation and the expectation that this will persist, long-side speculation will remain low and have a muted effect on price as we have seen.
The net speculative long position has been variable over the past year ranging between 135 million and 312 million barrels with an average of about 219 million barrels, which is down about 4 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.