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Petroleum Market Commentary - January 2, 2012

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Iran Continues to Rattle Sabre

During the week ending December 30th, the spot month heating oil futures price increased by 4.43 cents per gallon (+1.53%) while the deferred months increased by 0 to 2 cents per gallon making the forward pricing curve relatively unchanged in level and more negatively sloped. The one year forward price ended the week at a 6.16 cent (2.10%) discount to the spot price, from a discount of 1.74 cents (0.60%) at the end of the previous week.

The change in level and shape of the forward pricing indicates no change in the balance of supply, supply expectations, demand, and demand expectations. It does indicate the increased risk of supply disruption as can be seen with the first three months increasing while the rest of the curve is virtually unchanged. The negative slope of the forward pricing curve indicates relatively tight inventories with respect to demand and demand expectations some of which is due to supply disruption risk that continues due to the situation in Iran. A negatively sloped forward pricing curve is usually accompanied by general price strength.

The US Dollar increased on the week exerting downward pressure on petroleum prices, the stock market decreased exerting downward pressure on prices while lower petroleum demand kept downward pressure on prices. Overall petroleum inventories grew unexpectedly and vs. the five year average which kept downward pressure on prices.

Speculation increased on the week, mostly due to the Iranian situation, which was positive for price. Price and speculative levels continue to have a weak statistical relationship suggesting that the linkage is stronger when the level of speculation is extreme. The statistical relationship has become stronger in recent weeks.

Weekly US petroleum demand decreased by 4.27% on a week over week basis for the week ending December 23rd.

Prices remain in the middle of the range that they have been in over the last twelve months and near the middle of the range that we have seen in the past six months which maintains the relative attractiveness of adding to short and medium term hedge positions. Longer-term positions can be entered into in order to establish cost certainty in forward periods at relatively attractive prices. Hedging in the short-term at these prices is to capture opportunity in so far as opportunity has not been addressed previously and for the management of budget risk as needed. As prices move and as time passes, the advisability of medium to longer-term hedging will change.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of December 30th.

Factors affecting the market on the week

Macro factors:

US economic data and news including:

Global economic data and news including:

During the week ended December 23rd, total petroleum inventories increased by 4.41 million barrels vs. a five year average decrease of 3.08 million barrels and vs. an expected decrease of 4.35 million barrels. Inventories increased by 7.49 million barrels vs. the five year average. Total inventories stand at 685.5 million barrels up from 681.1 million barrels at the end of the previous week. The five year average inventory is 672.4 million barrels, down from 675.4 at the end of the previous week. Current inventories are 1.96% larger than the five year average down from +0.84% at the end of the previous week.

As of December 27th, the net speculative long position in petroleum futures was 273,398,000 barrels up 24,326,000 barrels (+9.77%) from the previous week. This position represents 39.88% of domestic inventories. Speculation is 7.23% below its one year moving average and is 33.05% lower than the 52 week high and slightly lower than the high levels in 2010. The corresponding spot month heating oil futures price on December 27th was 290.85 cents per gallon, up 5.91 cents from 284.94 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 39.66% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 15.72% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has continued to be weak over the past few months and, considering the past year's data, has become somewhat irrelevant but is worth monitoring as an indicator of how the hedger is competing with the speculator for forward pricing. It has, however, stopped declining and has increased slightly in the past several weeks. 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 heating oil futures price would be 261.59 cents per gallon or 29.26 cents per gallon less than current prices. The analysis would indicate that about 10.06% of current price is attributable to speculation and its underlying market rationale. The "would be" price has come up by over $1 per gallon over the past seven months and the percent of price attributable to speculation has decreased. The "would be" price decreased about one cent on the week. This would suggest that speculation was ahead of market fundamentals that have now been realized.

The net speculative long position has been variable over the past year ranging between 70 million and 410 million barrels with an average of about 295 million barrels.

The graph below is three year history of speculative position levels.

Linwood Capital, LLC is an institutional fuel hedging management and consulting firm. Linwood creates and manages customized fuel hedging programs primarily for public clients on a nationwide basis.