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Dollar Higher - Speculation Higher - Inventory Higher - Prices Lower
During the week ending September 7th, the spot month diesel futures price decreased by 2.49 cents per gallon (-1.11%) while the deferred months decreased by 1-3 cents per gallon making the forward pricing curve lower but relatively unchanged in slope. The one year forward price ended the week at a 1.27 cent discount to the spot price, from a discount of 2.32 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 September 7th, the spot month gasoline futures price decreased by 2.70 cents per gallon (-1.35%) while the deferred months decreased by 1-4 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 4.42 cent discount to the spot price, from a discount of 7.42 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 higher on the week.
Weekly US petroleum demand decreased by 2.14% during the week ending August 31st. Domestic demand is up by 3.02% vs. one-year ago and demand is currently 6.50% above the five year average.
Domestic production was unchanged on the week and is 25.27% above year ago levels. The number of operating oil drilling rigs in the US decreased from 862 to 860 on the week. Currently, this is 544 more than the low of 316 rigs in 2016 and 46.55% 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 2,572,000 barrels per day (+30.52%) since the low on July 1, 2016.
Below is the one-year chart of spot diesel futures prices as of September 7th.
Below is the one-year chart of spot gasoline futures prices as of September 7th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories increased on the week by 0.66 million barrels while inventories were expected to decrease by 3.64 million barrels on the week. The five-year average inventory decreased by 0.44 million barrels. Inventories increased vs. the five year average and vs. expectations.
: : Prices remain at the top of the range that they’ve been in over the past four months. The general themes are expectations of a supply crunch caused by Iranian sanctions and demand weakness due to tariffs, etc. which would slow global economic growth and petroleum demand growth.
: : Tropical storm Gordon proceeded through the Gulf of Mexico and caused prices to increase slightly on the evacuation of some rigs and the general risk surrounding tropical weather.
: : Iranian production has already begun to decline as they have fewer countries that are willing to buy from them ahead of the sanctions being reinstated as of November 1st. South Korea has already gone to zero purchases from Iran.
: : The stock markets of emerging economy countries have fallen into bear market status. The petroleum market fears that these negative stock markets might translate into a softer global economy which would be negative for petroleum demand growth expectations and price.
: : The Stock market decreased by -1.03% which is negative for general economic activity and is positive for petroleum prices.
: : The US Dollar increased by +0.24% 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 940,000 barrels per day from May to August.
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 September 7th.
Below is the one-year chart for the US dollar index as of September 7th.
During the week ended August 31st, total petroleum inventories increased by 0.66 million barrels vs. a five year average decrease of 0.44 million barrels and vs. an expected decrease of 3.64 million barrels. Inventories increased by 1.10 million barrels vs. the five year average and increased by 4.30 million barrels vs. expectations. Total inventories stand at 769.2 million barrels, up from 768.6 million barrels at the end of the previous week. The five year average inventory is 768.6 million barrels, down from 769.1 million barrels at the end of the previous week.
Current inventories are +0.08% versus the five year average, up from -0.06% at the end of the previous week. Inventory has been steady vs. the five year average since May.
As of September 4th, the net speculative long position in petroleum futures was 510,898,000 barrels, up 13,451 barrels (+2.70%) from the previous week. Speculation increased for the second week and represents 66.42% of domestic inventories. Speculation is 3.63% below its one year moving average. The corresponding spot month diesel futures price on September 4th was 225.47 cents per gallon, up 4.33 cents from 221.14 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 52.70% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 27.78% of diesel fuel price movements are explained by changes in level of speculation. One-year correlation has declined sharply in the past month.
The net speculative long position has been variable over the past year ranging between 272 million and 703 million barrels with an average of about 530 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 September 4th, the market price for spot month diesel futures is estimated to be 191.89 versus the actual price of 225.47. This indicates that the market is currently overvalued by 33.58 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.