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Petroleum Market Commentary - January 20, 2014

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Prices Steady - Inventories Lower - Speculation Lower - Production Higher

DIESEL:

During the week ending January 17th, the spot month diesel futures price increased by 8.30 cents per gallon (+2.82%) while the deferred months changed by between up 1 cents and down one cent making the forward pricing curve unchanged in level and slope except for the first three months. The one year forward price ended the week at a 16.97 cent (5.61%) discount to the spot price, from a discount of 8.18 cents (2.78%) and the end of the previous week.

The change in level and slope of this forward pricing curve indicates steady demand expectations and steady supplies with respect to demand except higher demand in the near-term due to winter distillate heating demand caused by colder than normal temperatures. Demand includes speculative demand. 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.

GASOLINE:

During the week ending January 17th, the spot month gasoline futures price decreased by 4.87 cents per gallon (-1.82%) while the deferred months decreased by 1 to 5 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 12.99 cent (5.22%) discount to the spot price, from a discount of 16.31 cents (6.51%) 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.

ANALYSIS:

The US dollar was higher on the week which is negative for price. Inventories on the week were lower which is positive for price. The stock market, as a proxy for demand expectations, was lower which is negative for price. Speculation was lower on the week which is negative for price. US domestic crude production increased to yet another 25 year high which is generally negative for price.


Weekly US petroleum demand increased by 3.49% during the week ending January 10th. Demand is up 4.23% vs. one year ago and demand is currently 3.86% above the five year average.

The attractiveness of making new hedges increased on the week since speculation was lower. Speculation was lower on the week making new hedging involve less competition with speculators for new long positions which is advantageous for the hedger. However, prices remained relatively stationary in forward time frames making the attractiveness of prices unchanged. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging will become more attractive.

Below is a one year chart of spot diesel futures prices as of January 17th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of January 17th.

Factors affecting the market on the period were:

During the week ended January 10th, total petroleum inventories decreased by 2.50 million barrels vs. a five year average increase of 5.01 million barrels and vs. an expected increase of 1.40 million barrels. Inventories decreased by 7.51 million barrels vs. the five year average. Total inventories stand at 707.3 million barrels, down from 709.8 million barrels at the end of the previous week. The five year average inventory is 715.3 million barrels, up from 710.3 million barrels at the end of the previous week.

Current inventories are 1.11% smaller than the five year average down from -0.06% at the end of the previous week. Inventories versus the five year average on a percentage basis are negative for the second week in a row and the lowest level versus the five year average since October of 2012.

As of January 14th, the net speculative long position in petroleum futures was 270,566,000 barrels down 40,755,000 barrels (-13.09%) from the previous week. Speculation decreased for the second week in a row and represents 38.25% of domestic inventories. Speculation is 11.50% below its one year moving average and is 36.92% below the 52-week high set on July 23rd. The corresponding spot month heating oil futures price on January 14th was 293.63 cents per gallon, down 2.30 cents from 295.93 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 75.66% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 57.24% of the price movement of diesel fuel is explained by changes in levels of speculation. This statistical relationship continues to strengthen in an environment of relatively high speculation which tends to increase correlation. Other fundamental factors such as higher domestic production remain as important price drivers in the current environment. 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 259.80 cents per gallon or 33.83 cents per gallon less than current prices. The analysis would indicate that about 11.52% of current price is attributable to speculation and its underlying market rationale. The "would be" price was down by about half a cent on the week.

The net speculative long position has been variable over the past year ranging between 181 million and 429 million barrels with an average of about 306 million barrels, which was unchanged on the week.

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

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, natural gas, and electricity on a nationwide basis.