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Dollar Higher - Speculation Plummets - Production Lower - Stock Market Lower - Inventory High vs. FYA - Prices Steady/Lower
During the week ending October 26th, the spot month diesel futures price increased by 0.10 cents per gallon (+0.04%) while the deferred months changed between -2 and +1 cents per gallon making the forward pricing curve steady and relatively unchanged in slope. The one year forward price ended the week at a 1.18 cent discount to the spot price, from a premium of 0.27 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates steady 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 October 26th, the spot month gasoline futures price decreased by 9.89 cents per gallon (-5.17%) while the deferred months decreased by 5-11 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 4.63 cent premium to the spot price, from a premium of 2.44 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 increased by 7.67% during the week ending October 19th. Domestic demand is up by 3.65% vs. one-year ago and demand is currently 5.10% above the five year average.
Domestic production was steady on the week and is 14.65% above year ago levels. The number of operating oil drilling rigs in the US increased from 873 to 875 on the week. Currently, this is 559 more than the low of 316 rigs in 2016 and 45.62% lower than the peak of 1609 in October 2014. This high rig count is causing US production to generally 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 October 26th.
Below is the one-year chart of spot gasoline futures prices as of October 26th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories decreased on the week by 0.74 million barrels while inventories were expected to increase by 0.42 million barrels on the week. The five-year average inventory decreased by 4.32 million barrels. Inventories increased vs. the five year average and decreased vs. expectations.
: : Saudi Arabia has indicated that it will fill any supply gap caused by sanctions on Iran. This clears up some supply uncertainty and makes a well-supplied market a more likely scenario as we move into the Iranian sanctions period.
: : The global rout in equity markets has caused expectations of lower global economic growth rates which means lower global petroleum demand growth rates which is negative for price.
: : US inventories are at year to date highs when viewed versus the five year average. Higher inventory levels are negative for price.
: : With these negative market factors, speculation has decreased to one-year lows since investors see less upside in petroleum prices at this time.
: : The Stock market decreased by -3.94% which is negative for general economic activity and is positive for petroleum prices.
: : The US Dollar increased by +0.67% 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 970,000 barrels per day from May to September.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of October 2018. According to the chart, global supply has been about 600,000 barrels per day less than consumption for the past year but balanced for the fourth quarter of 2018 and then a slight surplus is forecasted for 2019. In earlier forecasts, there was more of a surplus for the remainder of 2018 and 2019 meaning that this updated forecast is more supportive of price.
Below is the one-year chart US stock market prices as of October 26th.
Below is the one-year chart for the US dollar index as of October 26th.
During the week ended October 19th, total petroleum inventories decreased by 0.74 million barrels vs. a five year average decrease of 4.32 million barrels and vs. an expected increase of 0.42 million barrels. Inventories increased by 3.57 million barrels vs. the five year average and decreased by 1.16 million barrels vs. expectations. Total inventories stand at 782.5 million barrels, down from 783.2 million barrels at the end of the previous week. The five year average inventory is 764.4 million barrels, down from 768.7 million barrels at the end of the previous week.
Current inventories are +2.37% versus the five year average, up from +1.89% at the end of the previous week. Inventory has been growing vs. the five year average since August and is the highest vs. FYA since January 5th.
One-year low speculation.
As of October 23rd, the net speculative long position in petroleum futures was 328,834,000 barrels, down 54,873,000 barrels (-14.30%) from the previous week. Speculation decreased for the third week and represents 42.02% of domestic inventories. Speculation is 39.35% below its one year moving average. The corresponding spot month diesel futures price on October 23rd was 224.84 cents per gallon, down 9.18 cents from 234.02 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are -33% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 11% of diesel fuel price movements are explained by changes in level of speculation. One-year correlation has declined sharply in the past several months and is now negative which is very unusual.
The net speculative long position has been variable over the past year ranging between 328 million and 703 million barrels with an average of about 542 million barrels, which is unchanged 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 23rd, the market price for spot month diesel futures is estimated to be 173.78 versus the actual price of 224.84. This indicates that the market is currently overvalued by 51.06 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.