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Prices Up - Inventory Down - Production Up - Speculation Up
During the week ending September 22nd, the spot month diesel futures price increased by 1.75 cents per gallon (+0.97%) while the deferred months increased by 0 to 3 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 9.15 cent discount to the spot price, from a premium of 8.62 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates steady demand expectations and steady inventories with respect to demand. Lower inventories are expected due to refining capacity being off-line due to Hurricane Harvey. This is why we see elevated spot and near-term prices and not in further forward prices. 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 22nd, the spot month gasoline futures price increased by 0.67 cents per gallon (+0.40%) while the deferred months changed between +1 and -1 cent per gallon making the forward pricing curve slightly higher and slightly more negatively sloped. The one year forward price ended the week at a 10.92 cent discount to the spot price, from a discount of 10.29 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates steady demand expectations and steady inventory levels with respect to supply and demand. Lower inventories are expected due to refining capacity being off-line due to Hurricane Harvey. This is why we see elevated spot and near-term prices and not in further forward prices.
The US dollar was higher on the week which is negative 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 11.72% on a year over year basis. Oil rig count indicating the number of oil wells currently being developed by drilling was lower by 5 on the week which is positive for price.
Weekly US petroleum demand increased by 3.69% during the week ending September 15th. Domestic demand is up by 0.53% vs. one-year ago and demand is currently 4.57% above the five year average.
Domestic production increased on the week to its pre-Harvey levels and is 11.72% above year ago levels. The number of operating oil drilling rigs in the US was down 5 and stands at 744 which is 24 lower than the recent high of 768. Currently, this is 428 more than the recent low of 316 in 2016 and 53.76% lower than the peak of 1609 in October 2014. The relatively high rig count is causing US production to grow as the global rebalancing of supply and demand continues. US domestic production has increased by 1,082,000 barrels per day (+12.84%) since the recent low on July 1, 2016 and has decreased by 100,000 barrels per day (-1.04%) 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 September 22nd.
Below is the one-year chart of spot gasoline futures prices as of September 22nd.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased for the fourteenth consecutive week and on the week were down by 3.23 million barrels while inventories were expected to decrease by 0.14 million barrels on the week. The five-year average inventory decreased by 2.89 million barrels. Inventories decreased vs. the five year average and vs. expectations.
: : The effects of hurricane Harvey are still being felt as domestic production and refining capacity utilization continue to come back to normal. From August 25th to September 8th, refining capacity utilization dropped from 96.60% to 77.70% and as of September 15th is at 83.20%. Until this returns to normal, diesel and gasoline prices will stay elevated by roughly 15 cents per gallon from where they would be. Domestic production dipped from the hurricane but has returned to normal.
: : The Iraqi oil minister mentioned that OPEC should reduce production by another 1% (about 300,000 barrels per day) in order to hasten the rebalancing of the global crude market and to support price. He indicated that some OPEC members favor extending the current cuts through the end of 2018.
: : The Stock market increased by +0.08% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increased by +0.33% 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.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of September 2017. According to the chart, global supply and demand have essentially rebalanced during the first half of 2017 and are expected to remain roughly in balance through 2018 with a slight surplus. This means firmer 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 September 22nd.
Below is the one-year chart for the US dollar index as of September 22nd.
During the week ended September 15th, total petroleum inventories decreased by 3.28 million barrels vs. a five year average decrease of 2.89 million barrels and vs. an expected decrease of 0.14 million barrels. Inventories decreased by 0.33 million barrels vs. the five year average and decreased by 3.09 million barrels vs. expectations. Total inventories stand at 827.9 million barrels, down from 831.1 million barrels at the end of the previous week. The five year average inventory is 732.2 million barrels, down from 735.1 million barrels at the end of the previous week.
Current inventories are 13.07% higher than the five year average, up from +13.06% at the end of the previous week.
As of September 19th, the net speculative long position in petroleum futures was 330,939,000 barrels, up 58,187,000 barrels (+21.33%) from the previous week. Speculation increased for the first time in two weeks and represents 39.97% of domestic inventories. Speculation is 10.51% above its one year moving average. The corresponding spot month diesel futures price on September 19th was 177.26 cents per gallon, up 3.20 cents from 174.06 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 69.71% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 45.59% 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 299 million barrels, which is up roughly 2 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 19th, the market price for spot month diesel futures is estimated to be 202.66 versus the actual price of 177.26. This indicates that the market is currently undervalued by 25.40 cents per gallon given the assumptions of the pricing model.