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Petroleum Market Commentary - January 16, 2012

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Geopolitical Risk Continues to Support Market

During the week ending January 13th, the spot month heating oil futures price decreased by 4.30 cents per gallon (-1.40%) while the deferred months decreased by 3 to 4 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 2.15 cent (0.71%) discount to the spot price, from a discount of 4.88 cents (3.05%) at the end of the previous week.

The change in level and shape of the forward pricing indicates a decrease in demand expectations (some of which is speculative demand due to supply disruption risk) and an increase in inventory levels with respect to supply and demand. The negative slope of the forward pricing curve continues to indicate relatively tight inventories with respect to demand and demand expectations. A negatively sloped forward pricing curve is usually accompanied by general price strength.

The US Dollar increased again on the week to another one-year+ high exerting downward pressure on petroleum prices, the stock market increased again exerting upward 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. The market managed to remain relatively elevated due to continued fear of supply disruption from the Iranian situation despite downward pressure on price from higher inventories, lower demand, and a stronger dollar. When and as the risk of supply disruption abates, price will correct.

Speculation increased again for the third week in a row, mostly due to the continuing 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 1.18% on a week over week basis for the week ending January 6th. Demand is down 6.71% vs. one year ago. Some of this decrease in demand has to do with unseasonably warm weather in the Northeast and the specific lack of demand for home heating oil.

Prices remain in the top of the range that they have been in over the last twelve months. This makes adding to hedge positions at these levels relatively undesirable. Hedging in the short-term at these prices is for the management of budget risk only. As prices move and as time passes, the advisability of medium to longer-term hedging will change and become more favorable.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of January 13th.

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 January 6th, total petroleum inventories increased by 12.55 million barrels vs. a five year average increase of 7.99 million barrels and vs. an expected increase of 5.75 million barrels. Inventories increased by 4.56 million barrels vs. the five year average. Total inventories stand at 706.0 million barrels up from 693.5 million barrels at the end of the previous week. The five year average inventory is 682.8 million barrels, down from 674.8 at the end of the previous week. Current inventories are 3.41% larger than the five year average up from +2.44% at the end of the previous week. Versus the five year average, inventories continue to be at a three month high.

As of January 10th, the net speculative long position in petroleum futures was 303,057,000 barrels up 9,135,000 barrels (+3.11%) from the previous week. This position represents 42.93% of domestic inventories. Speculation is 2.95% above its one year moving average and is 25.79% lower than the 52 week high and at the high levels for 2010. The corresponding spot month heating oil futures price on January 10th was 310.14 cents per gallon, up 6.32 cents from 303.82 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 47.42% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 22.49% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has strengthened in the past month and has become somewhat more relevant. When speculation is due to fear of supply disruption, the relationship tends to be stronger in the short-term. 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 261.71 cents per gallon or 48.43 cents per gallon less than current prices. The analysis would indicate that about 18.51% 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 and has been relatively stable over the past several months. This would suggest that speculation was ahead of market fundamentals that have now been nearly 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 294 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.