Fundamental Analytics Monthly Newsletter February 2019

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Monthly Newsletter: February 2019
February 04, 2019 | by Aaron Edwards and Joel Fingerman
Dear Joel:
Fundamentals
The DOE report of January 30 was again very bullish to gasoline prices. Total Motor Gasoline Inventories decreased by 2.2 million barrels to 257.4 million barrels for the week ending January 25, 2019 (Chart 1, black line). The expectations average was for a 1.9 million barrel increase. Gasoline cracks should start to increase in value. By mid-February, refiners will move to driving season gasoline production.
Chart 1
Total Distillates Stocks decreased by 1.1 million barrels to 141.3 million barrels for the week ending January 25, 2019, while expectations average was for a 1.4 million barrel draw (Chart 2, black line). The DOE report was mixed for distillates prices as stocks decreased but demand was down. Stocks data are bullish for prices while demand data are bearish for prices so these data do not provide a clear price direction implication.
Distillate cracks may indicate future direction and economic dynamics of crude oil: An increase in the crack would indicate rising demand, while a fall could reflect economic weakness. The heating oil crack spread could become a useful indicator for the price of crude oil and tell us if the current rally in WTI prices will continue.
Chart 2
Platform Potential
The commodity market research platform offered by Fundamental Analytics is intuitive and easy to use. The year-on-year default visualizations offer a superb tool for analyzing both fundamental and pricing data. Highly customizable features also facilitate price comparisons between different commodities. Research by our team in January, presented below, exemplifies how our platform can facilitate fundamental and pricing analysis of multiple commodities.
Note: The comments below reflect updates and commentaries that we send regularly to our distribution lists. Because some time has now passed since its original release, the content below should not be regarded as up-to-date market commentary. If you wish to receive this type of analysis in a timely fashion, please let us know. In addition, you can conduct your own research by subscribing to our research platform. For more information give us a call at (859) 687-2748 or visit www.fundamentalanalytics.com.
Commentary originally from January 24th
Corn is the raw material used to produce biofuel ethanol in the United States. About 40% of the US corn crop goes to the production of ethanol. Although corn prices rebounded from their lows last September, ethanol prices have continued to weaken.
In fact, ethanol prices in equivalent bushel prices (1 bushel of corn produces 2.8 gallons of ethanol) have recently moved lower than corn prices. Chart 1 plots corn prices (black line) and equivalent ethanol prices (red line). When the black corn line is above the red ethanol line the spread, or margin, is negative.The negative margin means the ethanol output is priced lower than the price of corn needed for the production of ethanol. This bearish scenario provides trading opportunities for traders of ethanol outrights and ethanol-corn spreads.
Chart 1
Chart 2 provides a year-on-year overlay of the spread between ethanol and corn. The black line, the 2019 spread, is at record lows around -20 cents. Ethanol refiners are currently running at a loss. Ethanol inventories are near record high levels for this time of the year, so supply is plentiful (Chart 3). Ethanol production dropped throughout December, but has recovered and is currently at a strong level similar to the previous two years (Chart 4). Production alone is not a sufficient trading signal, but, in context, it provides a bearish outlook.
Ethanol stocks are at record highs. Production is strong. Unless ethanol demand grows, ethanol prices remain bearish.
The spread between ethanol and corn (Chart 2, black line) has been dropping since mid-September. Assuming bearish ethanol prices, this spread can be expected to continue dropping as long as corn prices are stable or increasing. Based on the seasonal pattern of the last three years (Chart 5), it is reasonable to assume that the MAR CBOT corn contract will be stable or rising between January and its expiration. Thus, expectations are bearish for the ethanol-corn spread as well.
Chart 2
Chart 3
Chart 4
Chart 5
Weekly Commentary Summary
Fundamental Analytics offers timely weekly commentaries tied to reporting from the DOE, as well as weekly reports on crude oil and natural gas. We also offer a weekly commodity market update highlighting developments in agricultural and energy markets. If you are interested in receiving any or all of these updates, please let us know. Below are some summaries of our January Commodity Market Updates.
Note: The comments below reflect updates and commentaries that we send regularly to our distribution lists. Because some time has now passed since its original release, the content below should not be regarded as up-to-date market commentary. If you wish to receive this type of analysis in a timely fashion, please let us know. In addition, you can conduct your own research by subscribing to our research platform. For more information please give us a call at (859) 687-2748 or visit www.fundamentalanalytics.com.
January 8
Energy
January is the start of refineries turnaround, when parts of the refineries are shut down for maintenance and preparation for the summer driving season. There is a drop in Crude Runs in the refineries through January and into February. Correspondingly, there is a drop in the production of gasoline during this period as demand for gasoline is lower in January.
Grains
Corn is the raw material in the production of biofuel ethanol in the US. About 40% of the US corn crop is used in the production of ethanol. Corn prices have rebounded since mid-September, but ethanol prices remain low. In fact, Ethanol prices in equivalent bushel prices (1 bushel of corn produces 2.8 gallons of ethanol) are lower than corn prices. Ethanol refiners are currently running at a loss. Ethanol inventories are at record high levels for this time of the year, so supply is plentiful. Consequently, ethanol refiners have been cutting production. For the week ending December 28, ethanol production dropped by 31,000 barrels per day.
January 16
Energy
Natural Gas prices gapped up on Monday due to cold weather and cold weather forecasts.
Natural Gas production remains strong but storage, as reported by the EIA for January 4, 2019, is at a record low of 2,614 bcf for this time of the year. The computer model forecast of storage by the end of the winter season has storage at about 1,400 bcf for a normal cold winter. Should the current seasonally colder winter weather continue for extended periods, storage would end up closer to 1,200 bcf. Low storage will cause prices to rise.
The March-April Natural Gas calendar spread is a measure of traders’ expectation of end of winter storage levels. Expectation of low storage widens the spread. On Monday, the spread increased. In 2014, shortage ended at a record low and the 2014 March-April Natural Gas calendar spread spiked. The current March-April Natural Gas calendar spread has been as high and could even reach the level it reached in mid-November 2018 $1.58 in mid-November.
January 23
Energy
US domestic crude oil prices are often influenced by global events. On Monday the International Monetary Fund reported an increased possibility of a global economic slowdown and reduced its 2019 global growth forecast to 3.5% from 3.7%. Also on Monday China reported the lowest annual economic growth in nearly 30 years. The annual economic growth rate of China was 6.6% in 2018. Crude oil prices dropped nearly 2% in reaction to the global news.
In contrast, US domestic natural gas prices are not affected by global economic events but rather by US domestic factors of supply/demand and weather. However, those factors are often not sufficient to explain natural gas price behavior. Last Friday prices were up in response to cold weather forecasts. Yet, when the cold weather materialized, prices dropped sharply on Tuesday, down over 12%. This price behavior illustrates the difficulty and risk of speculating in natural gas.
January 30
Energy
Since mid-December prices have dropped from $4.00 to $2.87, 28%, as of Monday’s settle. During the same time period March Open Interest increased from 216,000 contracts to 307,000 contracts, a 42% increase. As a general rule, when open interest grows as prices are falling this is an indication of new shorts in the market.
Last weekend a new extended forecast predicted milder winter in early February. Despite the severe cold weather this week in much of the US, the market gapped down on Monday in response to the longer term forecast. Being short natural gas in mid-winter can be a risky position, especially with the relatively low natural gas shortage level. In mid-November prices had an explosive up move when cold weather forecasts were released. Those holding short positions in winter are more sensitive to upside risks and will quickly cover if prices turn.  A new cold weather forecast in the next days or weeks is likely to create dramatic price up moves from a short covering rally given the high price volatility in natural gas.
The full content of our weekly commentaries can be accessed on our website at www.fundamentalanalytics.com/articles. Weekly commentaries and updates will be free until April. Effective April 2019, a subscription will be required in order to receive them. Of course, clients of Fundamental Analytics and BlackSummit Financial Group will continue receiving them for free.
What to Watch in Upcoming Weeks
Below are a few things to watch in early/mid-February of 2019. These factors are likely to impact energy and agricultural markets.
●     Ag Market response to delayed USDA reports
●     Magnitude of losses to South American soybean crop
●     Gasoline cracks and refineries moving to driving season production levels.
●     Distillate cracks may indicate future direction of crude oil.
●     US sanctions on PDVSA, the Venezuelan state-owned oil company, are in line with expectations but may have little impact on price.
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Regards,
The Fundamental Analytics Team
Disclosure
Trading and investment carry a high level of risk, and Fundamental Analytics LLC does not make any recommendations for buying or selling any financial instruments. We offer educational information on ways to use our sophisticated research analysis platform, but it is up to our customers and other readers to make their own trading and investment decisions or to consult with a registered advisor. The opinions expressed here are solely those of the author and do not constitute advice by Fundamental Analytics or its affiliates.