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Prices Increase to One-Year High - Speculation Spikes to 2 Year High
During the week ending October 7th, the spot month diesel futures price increased by 4.10 cents per gallon (+2.67%) while the deferred months increased by 4 to 6 cent per gallon making the forward pricing curve higher and virtually unchanged in slope. The one year forward price ended the week at a 10.29 cent premium to the spot price, from a premium of 9.23 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates higher demand expectations and steady inventories with respect to demand. Demand includes speculative demand which increased 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 October 7th, the spot month gasoline futures price increased by 1.87 cents per gallon (+1.28%) while the deferred months increased by 3 to 6 cents per gallon making the forward pricing curve higher and more positively sloped. The one year forward price ended the week at a 2.66 cent premium to the spot price, from a discount of 1.01 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates higher demand expectations and higher inventory levels with respect to supply and demand. Demand includes speculative demand which was higher on the week.
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 lower which is negative for price. Speculation was sharply higher on the week which is positive for price. US domestic crude production was lower which is positive for price. Domestic production is down 7.69% 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 increased by 6.94% during the week ending September 30th. Domestic demand is up 2.97% vs. one-year ago and demand is currently 5.17% above the five year average.
Domestic production decreased for the second week after reaching a three week high. Current production is 7.69% below year ago levels. The number of operating oil drilling rigs in the US increased or were flat for the 15th week in a row and the 17th time in 19 weeks and stands at 428 which is 3 more than the previous week, 112 more than the recent low of 316 and 73.40% 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 752,000 barrels per day since the beginning of the year and 1,143,000 barrels per day 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 October 7th.
Below is the one-year chart of spot gasoline futures prices as of October 7th.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased by 5.11 million barrels while inventories were expected to decrease by 0.20 million barrels on the week. The five-year average inventory increased by 1.04 million barrels. Inventories decreased vs. the five year average and vs. expectations.
: : OPEC's plan to reduce production by 700,000 barrels per day continue to support price. OPEC has indicated that it wishes to cap production a 32.5 to 33.0 million barrels per day which is about what their average production was for the first half of 2016 and is a very high historical level. So even though OPEC has promised to freeze production, it will be frozen at a higher level and most likely will have little effect on curtailing the current global oil glut. Their action may even worsen the glut because the price increase that we have seen due to the announcement of supply cuts will allow other producers, especially US shale producers, to increase production at profitable prices by hedging forward production in the $55 per barrel range.
: : US shale producers have been hedging in droves, and hedging of oil production has increased to a five-year high level. This indicates that US shale producers will increase production at current price levels which will increase supply and will be negative for price.
: : Goldman Sachs predicts that crude will not increase beyond $55 in the short to medium-term because of growth in supply at that price level which will prevent prices from increasing further.
: : Petroleum market fundamentals continue to be weak despite high prices. High prices will increase supply decreasing the likelihood that prices will remain elevated.
: : The Stock market decreased by -0.67% which is negative for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by 1.22% 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 August and September. Supply and demand are in the process of re-balancing which is the main cause of steady to higher price levels over the past 6 months. The August and September 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. The rebalancing of the market will most likely not return prices to the levels of two years ago. Significant price increase will be the result of a significant increase in demand.
Below is the one-year chart US stock market prices as of October 7th.
Below is the one-year chart for the US dollar index as of October 7th.
During the week ended September 30th, total petroleum inventories decreased by 5.11 million barrels vs. a five year average increase of 1.04 million barrels and vs. an expected decrease of 0.20 million barrels. Inventories decreased by 6.16 million barrels vs. the five year average and decreased by 4.91 million barrels vs. expectations. Total inventories stand at 887.9 million barrels, down from 893.0 million barrels at the end of the previous week. The five year average inventory is 726.4 million barrels, up from 725.3 million barrels at the end of the previous week.
Current inventories are 22.23% higher than the five year average, down from +23.11% at the end of the previous week.
Highest speculation level since July 2014.
As of October 4th, the net speculative long position in petroleum futures was 291,469,000 barrels, up 89,320,000 barrels (+44.19%) from the previous week. Speculation increased for the second week and represents 32.83% of domestic inventories. Speculation is 70.74% above its one year moving average. The corresponding spot month diesel futures price on October 4th was 155.44 cents per gallon, up 14.45 cents from 140.99 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 55.24% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 30.52% 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 292 million barrels with an average of about 171million barrels, which is up about 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 October 4th, the market price for spot month diesel futures is estimated to be 157.34 versus the actual price of 155.44. This indicates that the market is currently undervalued by 1.90 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.