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Dollar Higher - Speculation Higher - Inventory Higher - Production Lower - Rig Count Lower - Prices Lower
During the week ending August 3rd, the spot month diesel futures price decreased by 3.25 cents per gallon (-1.51%) while the deferred months decreased by 2-4 cents per gallon making the forward pricing curve lower but relatively unchanged in slope. The one year forward price ended the week at a 0.11 cent premium to the spot price, from a discount 0.21 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates lower current demand expectations and steady inventories with respect to demand. Demand also includes speculation 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 August 3rd, the spot month gasoline futures price decreased by 4.73 cents per gallon (-2.24%) while the deferred months decreased by 3-5 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at an 8.11 cent discount to the spot price, from a discount of 11.29 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower current demand expectations and lower inventory levels with respect to supply and demand. Demand also includes speculation which was higher on the week.
Weekly US petroleum demand decreased by 5.21% during the week ending July 27th. Domestic demand is up by 0.56% vs. one-year ago and demand is currently 3.26% above the five year average.
Domestic production decreased on the week and is 15.59% above year ago levels. The number of operating oil drilling rigs in the US decreased by 2 and stands at 859. Currently, this is 543 more than the low of 316 rigs in 2016 and 46.61% lower than the peak of 1609 in October 2014. This high rig count is causing US production to grow and is a factor in buffering supply disruptions in other parts of the world. US domestic production has increased by 2,472,000 barrels per day (+29.33%) since the low on July 1, 2016. For perspective, OPEC decreases in production since November 2016 amount to 1,540,000 barrels per day – less than the amount that US domestic production has grown during that time.
Below is the one-year chart of spot diesel futures prices as of August 3rd.
Below is the one-year chart of spot gasoline futures prices as of August 3rd.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories increased on the week by 4.25 million barrels while inventories were expected to decrease by 4.08 million barrels on the week. The five-year average inventory decreased by 3.25 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : Prices remain in a range as the market waits to see how current market factors play out. The US Dollar has risen to one year highs which is negative for price. Supply from OPEC is up another 300,000 barrels per day in July, inventories have steadied. The trade war with China still dominates the market picture. If the trade war escalates and persists, this will slow the global economy and petroleum demand growth.
: : The Stock market increased by +0.76% which is positive for general economic activity and is positive for petroleum prices.
: : The US Dollar increased by +0.52% on the week which 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.
OPEC Production Five Year History - Up 800,000 barrels per day from May to July.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of July 2018. According to the chart, global supply has been about 500,000 barrels per day less than consumption for the past year which has caused global inventories to decrease to near five year average levels and the second quarter of 2018 was surplus of about 500,000 barrels per day. The surplus is expected to remain in 2018 and increase in 2019. An expected surplus moving forward is negative for price.
Below is the one-year chart US stock market prices as of August 3rd.
Below is the one-year chart for the US dollar index as of August 3rd.
During the week ended July 27th, total petroleum inventories increased by 4.25 million barrels vs. a five year average decrease of 3.25 million barrels and vs. an expected decrease of 4.08 million barrels. Inventories increased by 7.50 million barrels vs. the five year average and increased by 8.33 million barrels vs. expectations. Total inventories stand at 763.9 million barrels, up from 759.7 million barrels at the end of the previous week. The five year average inventory is 776.9 million barrels, down from 780.2 million barrels at the end of the previous week.
Current inventories are 1.68% lower than the five year average, up from -2.63% at the end of the previous week. Inventory remains below the five year average and has been relatively steady vs. five year average for the past four months.
As of July 31st, the net speculative long position in petroleum futures was 551,360,000 barrels, up 12,388 barrels (+2.30%) from the previous week. Speculation increased for the second week and represents 72.17% of domestic inventories. Speculation is 7.85% above its one year moving average. The corresponding spot month diesel futures price on July 31st was 213.19 cents per gallon, down 0.07 cents from 213.26 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 73.97% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 54.72% of diesel fuel price movements are explained by changes in level of speculation. Higher levels of speculation typically cause higher correlation. Correlation continues to decrease.
The net speculative long position has been variable over the past year ranging between 226 million and 703 million barrels with an average of about 511 million barrels, which is up roughly 4 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 31st, the market price for spot month diesel futures is estimated to be 195.04 versus the actual price of 213.19. This indicates that the market is currently overvalued by 18.15 cents per gallon given the assumptions of the pricing model.
Three Year History of Producer Hedging
Producer hedging and speculation have each grown by 400-600 million barrels since June 2017 suggesting that speculators are buying from hedgers with an expectation that speculators will unwind their trade and hedgers will not and will deliver oil instead. This is causing a surge in production. Hedging levels are declining from highs near the lowest levels for 2018.
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.