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Petroleum Market Commentary - January 14, 2013

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Larger Inventories - Higher Speculation - Lower Dollar - Saudi Arabia - Pipeline

DIESEL:

During the week ending January 11th, the spot month heating oil futures price decreased by 0.92 cents per gallon (-0.30%) while the deferred months increased by 1 to 2 cents per gallon making the forward pricing curve generally higher and slightly less negatively sloped. The one year forward price ended the week at a 4.16 cent (1.38%) discount to the spot price, from a discount of 6.16 cents (2.04%) and the end of the previous week.

The change in level and shape of this forward pricing curve indicates slightly higher demand expectations and higher inventory levels with respect to supply and demand. Demand includes speculative demand which increased on the week and can be volatile. When the forward pricing curve decreases in slope (more negative or less positive), this usually indicates smaller inventories and is generally positive for price. When slope increases, this usually indicates larger inventories and is negative for price.

GASOLINE:

During the week ending January 11th, the spot month gasoline futures price decreased by 2.48 cents per gallon (-0.90%) while the deferred months increased by 0 to 2 cents per gallon making the forward pricing curve generally higher and less negatively sloped. The one year forward price ended the week at a 19.83 cent (7.80%) discount to the spot price, from a discount of 22.18 cents (8.72%) and the end of the previous week.

The change in level and shape of this forward pricing curve indicates higher demand expectations and higher inventory levels with respect to supply and demand.

ANALYSIS:

The "Fiscal Cliff" has passed and the threat of government action or inaction affecting the economy is no longer immediate. Larger than expected inventories on the week were negative for price. The US Dollar was lower supporting price. The stock market was higher which is positive for price. Speculation was up on the week which is supportive of price.

Weekly US petroleum demand decreased by 6.02% during the week ending January 4th. Demand is up 2.45% vs. one year ago and remains below the five year average.

The attractiveness of making new hedges decreased since prices were slightly higher and speculation was higher. Spot diesel prices remain near the middle of the price range that we have seen over the past twelve months. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging will become more attractive. Entering new, longer-term hedges at these levels would involve less competition with speculators for long futures positions and at relatively attractive prices. Spot heating oil futures in the $2.80 - $2.90 level will trigger additional hedging.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of January 11th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of January 11th.

Factors affecting the market on the period were:

During the week ended January 4th, total petroleum inventories increased by 15.50 million barrels vs. a five year average increase of 9.67 million barrels and vs. an expected increase of 6.40 million barrels. Inventories increased by 5.83 million barrels vs. the five year average. Total inventories stand at 725.1 million barrels, up from 709.6 million barrels at the end of the previous week. The five year average inventory is 690.2 million barrels, up from 680.5 at the end of the previous week.

Current inventories are 5.06% larger than the five year average up from +4.27% at the end of the previous week. Inventories versus the five year average on a percentage basis continue to be near eighteen month highs. This is negative for price and mitigates the effects of more speculation.

As of January 8th, the net speculative long position in petroleum futures was 276,051,000 barrels up 30,849,000 barrels (+12.58%) from the previous week. The level of speculation increased on the week and represents 38.07% of domestic inventories. Speculation is 3.10% above its one year moving average and is 32.46% below the 52 week high level. Levels have increased to the middle of the range that we have seen over the past two years and have become higher than the one year average. The corresponding spot month heating oil futures price on January 8th was 305.85 cents per gallon, up 1.34 cents from 304.51 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 82.99% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 68.87% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has stabilized and remains high. 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 244.88 cents per gallon or 60.97 cents per gallon less than current prices. The analysis would indicate that about 19.94% of current price is attributable to speculation and its underlying market rationale. The "would be" price is slowly rising, and was up again by about one cent on the week.

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 268 million barrels, an increase of roughly 1 million barrels on the week.

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.