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Prices Down - Speculation Higher
During the week ending December 5th, the spot month diesel futures price decreased by 5.34 cents per gallon (-2.47%) while the deferred months were lower by 0-5 cents per gallon making the forward pricing curve lower and more positively sloped. The one year forward price ended the week at a 7.92 cent premium to the spot price, from a premium of 5.28 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 higher 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 December 5th, the spot month gasoline futures price decreased by 5.42 cents per gallon (-2.97%) while the deferred months changed by +2 to -5 cents per gallon making the forward pricing curve mostly lower and more positively sloped. The one year forward price ended the week at a 4.17 cent premium to the spot price, from a premium of 0.26 cents and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and higher inventory levels with respect to supply and demand.
The US dollar reached an eight year high 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 higher on the week which is positive for price. US domestic crude production was higher on the week to another new 40 year high which is negative for price. Domestic production is up 13.38% year over year.
The market has now settled into a post-OPEC environment where the cartel's objective is not balancing world supply and demand and supporting prices but rather maintaining their market share regardless of price. The market is now doing the work of balancing supply and demand. This new environment will have more volatility and lower prices. Usually, demand is limited by supply. Now supply will be limited by demand. Instead of prices hovering just under the marginal value of utility in the upper end of the oil price range, prices will hover just above the marginal cost of production at the lower end of the oil price range.
The market will do its work and lower prices will curtail supply and/or increase demand especially in emerging economies and those economies that are more dependent upon petroleum and whose economic growth rate is more dependent upon cheap oil. Lower prices will mean higher economic growth rates for the world's economies which will, in turn, stimulate petroleum demand and will be positive for price. This will happen over the coming months and price will be supported.
Weekly US petroleum demand decreased by 3.17% during the week ending November 28th. Domestic demand is down 0.61% vs. one-year ago and demand is currently 7.29% over the five year average.
The attractiveness of making new hedges was higher on the week as prices were significantly lower while speculation was higher. From a flat-price basis, prices remain very attractive at four-year lows. The market should find support 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 December 5th.
Below is the one-year chart of spot gasoline futures prices as of December 5th.
: : Inventories increasing by 1.48 million barrels while inventories were expected to increase by 1.84 million barrels on the week. The five-year average inventory increased by 3.73 million barrels. Inventories decreased vs. the five year average and vs. expectations.
: : Saudi Arabia indicating that it will be pursuing the preservation of its market share and intends on allowing the market price to sort out supply and demand. This means that OPEC led by Saudi Arabia will not support prices with production cuts. This is negative for price.
: : The European Central Bank cutting its GDP growth forecasts for 2014 and 2015 is negative for economic growth prospects in Europe, negative for petroleum demand expectations and price.
: : Stronger than expected US November indications from the Institute of Supply Management (ISM). This is positive for domestic economic outlook, petroleum demand expectations and price.
: : Stock market increasing by 0.38% on the week to an all-time high is positive for economic and petroleum demand expectations and prices.
: : The US Dollar increasing by 1.11% to an eight 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 28th, total petroleum inventories increased by 1.48 million barrels vs. a five year average increase of 3.73 million barrels and vs. an expected increase of 1.84 million barrels. Inventories decreased by 2.24 million barrels vs. the five year average. Total inventories stand at 704.1 million barrels, up from 702.6 million barrels at the end of the previous week. The five year average inventory is 710.5 million barrels, up from 706.8 million barrels at the end of the previous week.
Current inventories are 0.91% lower than the five year average, down from -0.59% at the end of the previous week. Inventory levels continue to remain close to the five year average.
As of December 2nd, the net speculative long position in petroleum futures was 207,051,000 barrels up 27,662,000 barrels (+15.42%) from the previous week. This is the largest weekly percentage increase in speculation since July of 2013. Speculation increased for the first time in two weeks and represents 29.41% of domestic inventories. Speculation is 34.01% below its one year moving average. The corresponding spot month diesel futures price on December 2nd was 215.44 cents per gallon, down 24.04 cents from 239.48 cents per gallon during the previous week.
Diesel fuel price and size of speculative net long position in petroleum are 74.04% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 54.82% 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 234.68 cents per gallon or 19.24 cents per gallon more than current prices. The analysis would indicate that about -8.93% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 4 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 314 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.