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Prices Lower - Speculation Lower - US Production Lower - Inventory Up
During the week ending September 2nd, the spot month diesel futures price decreased by 10.15 cents per gallon (-6.72%) while the deferred months decreased by 8 to 10 cents per gallon making the forward pricing curve lower more positively sloped. The one year forward price ended the week at an 11.73 cent premium to the spot price, from a premium of 10.35 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 inventories with respect to demand. Demand includes speculative demand which decreased 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 September 2nd, the spot month gasoline futures price decreased by 12.68 cents per gallon (-8.88%) while the deferred months decreased by 7 to 11 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 7.19 cent premium to the spot price, from a premium of 5.97 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and higher inventory levels with respect to supply and demand. Demand includes speculative demand which was lower on the week.
The US dollar was higher on the week which is negative for price. Inventories on the week were higher which is negative for price. The stock market, as a proxy for demand expectations, was higher which is positive for price. Speculation was lower on the week which is negative for price. US domestic crude production was lower which is positive for price. Domestic production is down 7.92% on a year over year basis. Oil rig count indicating the number of oil wells currently being developed by drilling was higher on the week which is negative for price.
Weekly US petroleum demand decreased by 2.84% during the week ending August 26th. Domestic demand is up 1.30% vs. one-year ago and demand is currently 4.51% above the five year average.
Domestic production decreased for the second week after reaching a seven week high level. Current production is 7.92% below year ago levels. The number of operating oil drilling rigs in the US increased or were flat for the tenth week in a row and the 14th time in 16 weeks and stands at 407 which is 1 more than the previous week, 91 more than the recent low of 316 and 74.70% lower than the peak of 1609 in October 2014. A higher rig count is negative for price. The generally lower rig count is causing US production to move downward as part of the global rebalancing of supply and demand. US domestic production has decreased by 731,000 barrels per day since the beginning of the year and 1,122,000 barrels per day since the peak in June 2015.
Below is the one-year chart of spot diesel futures prices as of September 2nd.
Below is the one-year chart of spot gasoline futures prices as of September 2nd.
MARKET FACTORS & COMMENTARY:
: : Inventories increased by 3.08 million barrels while inventories were expected to decrease by 0.34 million barrels on the week. The five-year average inventory decreased by 2.61 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : Prices decreased this week on the waning prospects that oil producers in and out of OPEC would agree on a production freeze which would, if implemented, limit oil production at current levels among the participating producers who are mainly in OPEC. The problem with this is that Iran wants to continue to increase its production to pre-sanction levels before agreeing to a freeze in output. Even if they do agree, OPEC production levels are at all-time highs and so freezing at these levels will do little to rebalance the current imbalance of supply and demand in the global petroleum market.
: : Russian oil output declined to the lowest level in a year amidst maintenance at production facilities.
: : Oil discoveries are at a 70-year low level where exploration and production companies discovered in 2015 about 10% of what they have discovered on average since 1960 and this will likely decrease again in 2016. As demand increases, supply may not be able to keep up which will cause prices to rise.
: : The Stock market increasing by 0.56% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by +0.29% 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.
The charts below show supply and demand history and expectations for July and August. Supply and demand have begun to rebalance which is the main cause of generally higher prices levels over the past 6 months. The July and August forecasts indicate that the rebalancing of supply and demand globally will occur in 2017 which would be supportive of price. Of course, these projections are subject to many factors and constantly changing market conditions.
Below is the one-year chart US stock market prices as of September 2nd.
Below is the one-year chart for the US dollar index as of September 2nd.
During the week ended August 26th, total petroleum inventories increased by 3.08 million barrels vs. a five year average decrease of 2.61 million barrels and vs. an expected decrease of 0.34 million barrels. Inventories increased by 5.69 million barrels vs. the five year average and increased by 3.42 million barrels vs. expectations. Total inventories stand at 912.6 million barrels, up from 909.5 million barrels at the end of the previous week. The five year average inventory is 724.0 million barrels, down from 726.6 million barrels at the end of the previous week.
Current inventories are 26.05% higher than the five year average, up from +25.17% at the end of the previous week.
As of August 30th, the net speculative long position in petroleum futures was 258,981,000 barrels, down 22,245,000 barrels (-7.91%) from the previous week. Speculation decreased from the highest level since May 2015 and for the first time in four weeks and represents 28.38% of domestic inventories. Speculation is 58.12% above its one year moving average. The corresponding spot month diesel futures price on August 30th was 147.11 cents per gallon, down 3.07 cents from 150.18 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 44.67% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 19.95% 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 57 million and 282 million barrels with an average of about 164 million barrels, which is up about 1 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 30th, the market price for spot month diesel futures is estimated to be 145.75 versus the actual price of 147.11. This indicates that the market is currently overvalued by 1.36 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.