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Dollar Lower - Speculation Lower - Inventory Higher - Production Higher - Rig Count Higher - Prices Lower
During the week ending August 17th, the spot month diesel futures price decreased by 1.15 cents per gallon (-1.94%) 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 0.12 cent discount to the spot price, from a discount 1.06 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 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 August 17th, the spot month gasoline futures price decreased by 5.83 cents per gallon (-2.86%) while the deferred months decreased by 2-5 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 3.34 cent discount to the spot price, from a discount of 6.29 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 higher inventory levels with respect to supply and demand. Demand also includes speculation which was lower on the week.
Weekly US petroleum demand decreased by 3.54% during the week ending August 10th. Domestic demand is down by 1.63% vs. one-year ago and demand is currently 3.62% above the five year average.
Domestic production increased on the week and is 14.71% above year ago levels. The number of operating oil drilling rigs in the US was unchanged at 869, a new 3-year high. Currently, this is 553 more than the low of 316 rigs in 2016 and 46.00% 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.
Below is the one-year chart of spot diesel futures prices as of August 17th.
Below is the one-year chart of spot gasoline futures prices as of August 17th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories increased on the week by 9.631 million barrels while inventories were expected to decrease by 1.92 million barrels on the week. The five-year average inventory decreased by 4.09 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; domestic inventories have grown and are now in excess of their five year average. The trade war with China is affecting markets as any escalation or protraction of tariffs will slow economic growth and petroleum demand among the world’s two largest economies.
: : Turmoil in Turkey has caused a flight to the Dollar strengthening the Dollar which is negative for petroleum price. The situation in Turkey also increases risk of contagion to other areas and there is a risk of slowing economic growth in any affected areas.
: : What Iran’s production will be after sanctions are resumed on November 1st is a major uncertainty in the market. More than expected would be negative for price and vice versa. India and China will be the two major buyers of Iranian oil.
: : The Stock market increased by +0.59% which is positive for general economic activity and is positive for petroleum prices.
: : The US Dollar decreased by -0.27% on the week which 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.
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 August 2018. According to the chart, global supply has been about 500,000 barrels per day less than consumption for the past year but in surplus for the second quarter and for the first time since Q4 2016. This has caused domestic inventories to increase to above five year average levels this past week. In earlier forecasts, there was more of a surplus for the remainder of 2018 and 2019 meaning that this updated forecast is supportive of price at current levels.
Below is the one-year chart US stock market prices as of August 17th.
Below is the one-year chart for the US dollar index as of August 17th.
During the week ended August 10th, total petroleum inventories increased by 9.63 million barrels vs. a five year average decrease of 4.09 million barrels and vs. an expected decrease of 1.92 million barrels. Inventories increased by 13.72 million barrels vs. the five year average and increased by 11.55 million barrels vs. expectations. Total inventories stand at 776.3 million barrels, up from 766.7 million barrels at the end of the previous week. The five year average inventory is 770.4 million barrels, down from 774.5 million barrels at the end of the previous week.
Current inventories are +0.77% versus the five year average, up from -1.01% at the end of the previous week. Inventory increased to above the five year average for first time since March 16th.
As of August 14th, the net speculative long position in petroleum futures was 488,448,000 barrels, up 51,780 barrels (-9.58%) from the previous week. Speculation decreased for the second week and represents 62.92% of domestic inventories. Speculation is 5.63% below its one year moving average. The corresponding spot month diesel futures price on August 14th was 212.87 cents per gallon, down 4.04 cents from 216.91 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 69.80% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 48.73% 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 518 million barrels, which is up roughly 3 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 August 14th, the market price for spot month diesel futures is estimated to be 182.73 versus the actual price of 212.87. This indicates that the market is currently overvalued by 30.14 cents per gallon given the assumptions of the pricing model.
Five Year History of Producer Hedging
Producer hedging and speculation have each grown by roughly 400 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 and are at 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.