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Inventory Plummets - Dollar Plummets - Speculation Up
During the week ending July 21st, the spot month diesel futures price increased by 0.02 cents per gallon (+0.01%) while the deferred months decreased by 0 to 3 cents per gallon making the forward pricing curve generally lower and less positively sloped. The one year forward price ended the week at a 2.54 cent premium to the spot price, from a premium of 4.24 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates steady demand expectations and lower 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 21st, the spot month gasoline futures price increased by 0.28 cents per gallon (+0.18%) while the deferred months decreased by 0 to 2 cents per gallon making the forward pricing curve lower and less sloped. The one year forward price ended the week at a 0.13 cent discount to the spot price, from a premium of 1.37 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates steady demand expectations and lower inventory levels with respect to supply and demand. Demand includes speculative demand which was higher on the week.
The US dollar was lower on the week which is positive 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 11.00% on a year over year basis. Oil rig count indicating the number of oil wells currently being developed by drilling was lower on the week which is positive for price.
Weekly US petroleum demand increased by 6.11% during the week ending July 14th. Domestic demand is up by 2.10% vs. one-year ago and demand is currently 4.79% above the five year average.
Domestic production increased for the fourth week and is 11.00% above year ago levels. The number of operating oil drilling rigs in the US decreased by 1 and stands at 764. This is 448 more than the recent low of 316 and 52.52% 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 1,001,000 barrels per day (+11.88%) since the recent low on July 1, 2016 and has decreased by 181,000 barrels per day (-1.88%) 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 21st.
Below is the one-year chart of spot gasoline futures prices as of July 21st.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased by 11.31 million barrels while inventories were expected to decrease by 2.27 million barrels on the week. The five-year average inventory increased by 0.70 million barrels. Inventories decreased vs. the five year average and vs. expectations.
: : Second quarter Chinese GDP growth was slightly more than expected which is positive for demand expectations and price. Petroleum demand is strong in China where the most recent month was 10.66 million barrels per day, which is very near the all-time high. Interestingly, Chinese demand is still roughly half of US demand.
: : OPEC compliance with its production quotas fell from 110% in May to 92% in June. This indicates more supply on the market which is negative for price. OPEC is on track to produce 33 million barrels per day in July up from 32,550,000 in June: an increase of 450,000 barrels per day. Additionally, Libya has added 500,000 barrels per day since April. More supply weighs on market prices and may delay rebalancing.
: : The Stock market increased by +0.54% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreased by -1.36% on the week 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.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of July 2017. According to the chart, global supply and demand have essentially rebalanced during the first half of 2017 and are expected to remain in balance through 2018. This means firmer and volatile prices moving forward. There will need to be a period of deficit in order to deplete global inventories that have accumulated over the past several years. When, if, and to what extend this happens, prices will rise and we will return to a market more akin to 2012-2014 with high prices and backward forward pricing curves.
Below is the one-year chart US stock market prices as of July 21st.
Below is the one-year chart for the US dollar index as of July 21st.
During the week ended July 14th, total petroleum inventories decreased by 11.31 million barrels vs. a five year average increase of 0.70 million barrels and vs. an expected decrease of 2.27 million barrels. Inventories decreased by 12.01 million barrels vs. the five year average and decreased by 9.04 million barrels vs. expectations. Total inventories stand at 873.3 million barrels, down from 884.6 million barrels at the end of the previous week. The five year average inventory is 745.9 million barrels, down from 745.2 million barrels at the end of the previous week.
Current inventories are 17.07% higher than the five year average, down from +18.70% at the end of the previous week.
As of July 18th, the net speculative long position in petroleum futures was 218,787,000 barrels, up 44,022,000 barrels (+25.19%) from the previous week. Speculation increased for the third week and represents 25.05% of domestic inventories. Speculation is 37.20% below its one year moving average. The corresponding spot month diesel futures price on July 18th was 151.04 cents per gallon, up 3.41 cents from 147.63 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 85.92% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 73.82% 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 roughly unchanged 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 18th, the market price for spot month diesel futures is estimated to be 156.59 versus the actual price of 151.04. This indicates that the market is currently undervalued by 5.55 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.