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Prices Continue Up - Inventory at Two-Year Low - Speculation Spikes Up
During the week ending November 3rd, the spot month diesel futures price increased by 2.04 cents per gallon (+1.09%) while the deferred months increased by 0 to 4 cents per gallon making the forward pricing curve higher and generally more negative in slope. The one year forward price ended the week at a 3.56 cent discount to the spot price, from a premium of 4.62 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 also includes speculation which was higher on the week. Spot prices continue to be elevated with respect to forward prices due to refining capacity continuing to be off line due to Hurricane Harvey. 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 November 3rd, the spot month gasoline futures price increased by 7.60 cents per gallon (+4.43%) while the deferred months increased by 1 to 7 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 17.83 cent discount to the spot price, from a discount of 15.51 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates higher demand expectations and lower inventory levels with respect to supply and demand. Demand also includes speculation which was higher on the week. We continue to see elevated spot and near-term prices (and not in further forward prices) due to refining capacity that continues to be shut-in after hurricane Harvey.
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 12.10% on a year over year basis. Oil rig count indicating the number of oil wells currently being developed by drilling was lower by 8 on the week which is positive for price.
Weekly US petroleum demand decreased by 4.13% during the week ending October 27th. Domestic demand is down by 3.40% vs. one-year ago and demand is currently 0.33% below the five year average.
Domestic production decreased on the week and is 12.10% above year ago levels. The number of operating oil drilling rigs in the US was down 8 and stands at 729 which is 39 lower than the recent high of 768. Currently, this is 413 more than the recent low of 316 in 2016 and 54.69% 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 1,125,000 barrels per day (+13.35%) since the recent low on July 1, 2016 and has decreased by 57,000 barrels per day (-0.59%) 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 November 3rd.
Below is the one-year chart of spot gasoline futures prices as of November 3rd.
MARKET FACTORS & COMMENTARY:
: : Inventories decreased for the 20th consecutive week and on the week were down by 6.78 million barrels while inventories were expected to decrease by 4.32 million barrels on the week. The five-year average inventory increased by 0.82 million barrels. Inventories decreased vs. the five year average and vs. expectations.
: : The global petroleum market is returning to balance more quickly than expected on stronger global demand which is supported by strong global economic growth. The supply side of the equation is a function of OPEC compliance with its production targets and expectations of US production growth. OPEC appears to be very compliant with the production cuts (where there is an expectation that as a group, they would be less compliant and produce more). There is an expectation that the current production level of OPEC will be maintained through the end of 2018. What remains unknown is the extent to which and how rapidly US production can grow and be sustained. There are thousands of completed wells that have not yet been brought into production that could be brought into production in a short period of time causing a surge of US supply. This remains to be seen and weekly US production numbers will become an important indicator. Significant increases in US production would serve to limit the upward movement of price in the short-term.
: : Lower than normal refinery capacity due to hurricanes continues to elevate the price of gasoline and diesel given the current price of crude. These refinery disruptions continue to cause diesel and gasoline to be 10-15 cents per gallon more expensive than had the storms not occurred. It appears that this situation will persist for the next six months.
: : The Stock market increased by +0.26% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreased by +0.03% 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 October 2017. According to the chart, global supply and demand have essentially rebalanced during the first half of 2017 with a slight deficit and are expected to remain roughly in balance through 2018 with a slight surplus. This means firmer prices moving forward.
Below is the one-year chart US stock market prices as of November 3rd.
Below is the one-year chart for the US dollar index as of November 3rd.
During the week ended October 27th, total petroleum inventories decreased by 6.78 million barrels vs. a five year average increase of 0.82 million barrels and vs. an expected decrease of 4.32 million barrels. Inventories decreased by 7.59 million barrels vs. the five year average and decreased by 2.45 million barrels vs. expectations. Total inventories stand at 796.7 million barrels, down from 803.4 million barrels at the end of the previous week. The five year average inventory is 737.3 million barrels, up from 736.5 million barrels at the end of the previous week.
Current inventories are 8.06% higher than the five year average, down from +9.10% at the end of the previous week.
As of October 31st, the net speculative long position in petroleum futures was 429,609,000 barrels, up 64,274,000 barrels (+17.59%) from the previous week. Speculation increased for the second week in a row and represents 53.93% of domestic inventories. Speculation is 39.21% above its one year moving average. The corresponding spot month diesel futures price on October 31st was 188.45 cents per gallon, up 6.24 cents from 182.21 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 66.31% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 43.98% 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 309 million barrels, which is up roughly 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 October 31st, the market price for spot month diesel futures is estimated to be 206.83 versus the actual price of 188.45. This indicates that the market is currently undervalued by 18.38 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.