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Speculation Lower - Production to New Highs - Inventory Lower - OPEC
During the week ending November 24th, the spot month diesel futures price increased by 0.63 cents per gallon (+0.32%) while the deferred months increased by 1-3 cents per gallon making the forward pricing curve higher and less negative in slope. The one year forward price ended the week at a 4.93 cent discount to the spot price, from a premium of 6.48 cents at the end of the previous week.
The level and slope of the diesel forward pricing curve indicates steady demand expectations and higher 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 November 24th, the spot month gasoline futures price increased by 4.33 cents per gallon (+2.48%) while the deferred months increased by 1 to 4 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 12.08 cent discount to the spot price, from a discount of 9.62 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 lower inventory levels with respect to supply and demand. Demand also includes speculation which was lower on the week.
The US dollar was lower on the week which is positive 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 lower on the week which is negative for price. US domestic crude production was higher which is negative for price. Domestic production is up 11.14% on a year over year basis. Oil rig count, indicating the number of oil wells currently being developed, increased by 9 on the week which is negative for price.
Weekly US petroleum demand decreased by 2.36% during the week ending November 17th. Domestic demand is up by 0.09% vs. one-year ago and demand is currently 0.38% above the five year average.
Domestic production increased on the week and is 11.14% above year ago levels. The number of operating oil drilling rigs in the US increased by 9 and stands at 747 which is 21 lower than the recent high of 768. Currently, this is 431 more than the recent low of 316 in 2016 and 53.57% 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 and the return of global inventories to normal levels continues. US domestic production has increased by 1,230,000 barrels per day (+14.59%) since the recent low on July 1, 2016 and has increased past the old high from June 2015 of 9.61 million barrels per day.
Below is the one-year chart of spot diesel futures prices as of November 24th.
Below is the one-year chart of spot gasoline futures prices as of November 24th.
MARKET FACTORS & COMMENTARY:
: : Petroleum inventories decreased on the week and were down by 1.54 million barrels while inventories were expected to decrease by 2.00 million barrels on the week. The five-year average inventory increased by 2.75 million barrels. Inventories decreased vs. the five year average and increased vs. expectations.
: : OPEC is signaling that the production cuts that were implemented one year ago will be extended through 2018. OPEC wants this in order to drain the global overhang of petroleum inventories and to support price. But we’ve seen the movie before. OPEC curtails supply, prices go up driven by speculation, more production comes to the market, speculation evaporates, and prices go down. There are a number of factors that point to lower prices from here:
: : The Stock market increased by +0.91% which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar decreased by -0.94% on the week 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.
SUPPLY & DEMAND:
The chart below shows supply and demand history and expectations as of November 2017. According to the chart, global supply and demand have essentially rebalanced during the first three quarters of 2017 with a slight deficit and are expected to remain roughly in balance through 2018 with a slight surplus. This expectation of balance of supply and demand will be supportive of price.
Below is the one-year chart US stock market prices as of November 24th.
Below is the one-year chart for the US dollar index as of November 24th.
During the week ended November 17th, total petroleum inventories decreased by 1.54 million barrels vs. a five year average increase of 2.75 million barrels and vs. an expected decrease of 2.00 million barrels. Inventories decreased by 4.29 million barrels vs. the five year average and increased by 0.46 million barrels vs. expectations. Total inventories stand at 792.6 million barrels, down from 794.2 million barrels at the end of the previous week. The five year average inventory is 738.7 million barrels, up from 736.0 million barrels at the end of the previous week.
Current inventories are 7.30% higher than the five year average, down from +7.91% at the end of the previous week.
As of November 21st, the net speculative long position in petroleum futures was 509,232,000 barrels, down 12,758,000 barrels (-2.44%) from the previous week. Speculation decreased for the first time in five weeks and represents 64.24% of domestic inventories. Speculation is 56.20% above its one year moving average. The corresponding spot month diesel futures price on November 21st was 193.59 cents per gallon, up 2.89 cents from 190.70 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 70.47% correlated over the past 52 weeks indicating that, on a statistical basis over the past year that 49.66% 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 522 million barrels with an average of about 326 million barrels, which is up roughly 6 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 November 21st, the market price for spot month diesel futures is estimated to be 228.18 versus the actual price of 193.59. This indicates that the market is currently undervalued by 34.59 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.