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OPEC Leaves Production Unchanged - Prices Plummet to Four-Year Lows
During the week ending November 28th, the spot month diesel futures price decreased by 20.06 cents per gallon (-8.34%) while the deferred months were lower by 16-23 cents per gallon making the forward pricing curve sharply lower and more positively sloped. The one year forward price ended the week at a 5.28 cent premium to the spot price, from a premium of 4.93 cents at the end of the previous week.
The change in level and slope of the diesel forward pricing curve indicates lower demand expectations and higher supplies with respect to demand. Demand includes speculative demand 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 28th, the spot month gasoline futures price decreased by 15.46 cents per gallon (-7.52%) while the deferred months decreased by 21 to 23 cents per gallon making the forward pricing curve sharply lower and more positive slope. The one year forward price ended the week at a 0.26 cent premium to the spot price, from a premium of 0.55 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and steady inventory levels with respect to supply and demand.
The US dollar was slightly higher on the week which is negative for price. Inventories on the week were higher which is negative 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 on the week to another new all-time 40 year high which is negative for price. Domestic production is up 13.19% year over year.
The market was expecting production cuts to come from the OPEC meeting in Vienna last Thursday. OPEC did not cut production. This means that OPEC is no longer supporting price but maintaining its market share. The world supplies roughly 2 million barrels more than is consumed on a daily basis. Lower prices will decrease supply and increase demand in order that this imbalance is brought back into balance. The big news is that oil is now priced near and just above its marginal cost of production whereas OPEC had been holding price at or just below its marginal utility value. The problem with sustaining oil at just below the level where demand is destroyed is that it attracts more supply to the market - for OPEC this is a good short-term strategy but longer term, it is a formula for going out of business. More supply has come to the market especially from the United States over the past four years. OPEC is targeting US oil production with lower prices seeking to slow or outright decrease the production of US shale oil. How low prices need to go to decrease global supply remains to be seen.
Lower prices mean economic pain for oil exporting countries especially those countries that rely heavily on oil revenue for government funding and social programs. Russia, Venezuela, Nigeria and Iran will be those countries experiencing pain. This economic pain may also cause social unrest and cause other problems for these countries as well. For consuming countries, it is an economic tailwind and will increase the GDP of those countries.
Weekly US petroleum demand increased by 3.95% during the week ending November 21st. Domestic demand is down 1.19% vs. one-year ago and demand is currently 4.99% over the five year average.
The attractiveness of making new hedges was higher on the week as prices were significantly lower and speculation was lower. From a flat-price basis, prices remain very attractive at four-year lows. There should be support in the market at current prices since prices are very near to the marginal cost of some production which will act like a price floor and mitigate the risk of significant opportunity cost in new hedging. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging may become more attractive.
Domestic production was higher on the week to yet another new 40 year high level. Domestic production has grown by 3 million barrels per day in the past three years and is the major reason for lower prices and why OPEC did not cut production. This represents more than 3% of global daily consumption and roughly 15% of domestic consumption. Domestic production is affecting the global balance of political power as certain global powers rely more on oil revenues than others for their funding. Domestic production is relatively expensive however and further growth would be dampened by relatively low prices should lower prices persist. The number of oil drilling rigs employed in the United States has stayed steady over the past several months partially in response to weaker prices.
Below is the one-year chart of spot diesel futures prices as of November 28th.
Below is the one-year chart of spot gasoline futures prices as of November 28th.
: : Inventories increasing by 2.12 million barrels while inventories were expected to increase by 1.15 million barrels on the week. The five-year average inventory increased by 4.36 million barrels. Inventories decreased vs. the five year average and increased vs. expectations.
: : OPEC did not cut production at its meeting on November 27th. This signaled that OPEC would be maintaining its market share and that lower prices would be counted on to eliminate supply/increase demand by two million barrels per day. This sent the market plunging to a price that could curtail supply and/or increase demand.
: : The unexpected decline in US Consumer Confidence to a five month low level. This is negative for economic growth expectations petroleum demand expectations and price.
: : Inclement weather in the Northeast hampering highway travel and decreasing short-term demand for transportation fuels. This is negative for demand in the short term and negative for price in the short-term.
: : Stock market increasing by 0.20% on the week which is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by 0.05% to a new four and a half year high. This 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.
During the week ended November 21st, total petroleum inventories increased by 2.12 million barrels vs. a five year average increase of 4.36 million barrels and vs. an expected increase of 1.15 million barrels. Inventories decreased by 2.23 million barrels vs. the five year average. Total inventories stand at 702.6 million barrels, up from 700.5 million barrels at the end of the previous week. The five year average inventory is 706.8 million barrels, up from 702.4 million barrels at the end of the previous week.
Current inventories are 0.59% lower than the five year average, down from -0.28% at the end of the previous week. Inventory levels continue to remain close to the five year average.
As of November 25th, the net speculative long position in petroleum futures was 179,389,000 barrels down 11,417,000 barrels (-5.98%) from the previous week. Speculation decreased for the first time in three weeks and represents 25.53% of domestic inventories. Speculation is 43.19% below its one year moving average. The corresponding spot month diesel futures price on November 25th was 239.48 cents per gallon, up 1.35 cents from 238.13 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 75.31% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 56.72% of the price movement of diesel fuel is explained by changes in levels of speculation. A linear regression analysis over the past 52 weeks shows that if speculation were zero and the market forces causing speculation evaporated, that the spot month diesel futures price would be 239.63 cents per gallon or 0.15 cents per gallon more than current prices. The analysis would indicate that about -0.06% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 3 cents lower on the week.
The net speculative long position has been variable over the past year ranging between 166 million and 453 million barrels with an average of about 316 million barrels, which is down about 2 million barrels on the week.
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.