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Petroleum Market Commentary - February 25, 2013

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Lower Speculation - Lower Prices

DIESEL:

During the week ending February 22nd, the spot month heating oil futures price decreased by 10.62 cents per gallon (-3.31%) while the deferred months decreased by 6 to 10 cent per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 5.26 cent (1.69%) discount to the spot price, from a discount of 9.00 cents (2.80%) and the end of the previous week.

The change in level and slope of this forward pricing curve indicates lower demand expectations and an increase in supplies with respect to demand. Demand includes speculative demand which increased again on the week and can be volatile. 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 February 22nd, the spot month gasoline futures price decreased by 5.49 cents per gallon (-1.75%) while the deferred months decreased by 5 to 7 cents per gallon making the forward pricing curve lower and more negatively sloped. The one year forward price ended the week at a 40.84 cent (15.29%) discount to the spot price, from a discount of 37.62 cents (13.64%) and the end of the previous week.

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

ANALYSIS:

The US and global economy continued to show signs of improvement while some risk factors including Italian elections and the US Government Sequester draw near. Inventories on the week were smaller than expected and remain larger than historical averages. This keeps downward pressure on price but was supportive of price in the short term. The US Dollar was higher which is negative for price. The stock market was slightly lower which is positive for price. Speculation was lower on the week which was negative for price.

Weekly US petroleum demand decreased by 3.34% during the week ending February 15th. Demand is up 2.74% vs. one year ago and is 5.54% below the five year average.

The attractiveness of making new hedges increased on the week given the lower priced environment. Spot gasoline prices decreased slightly while diesel fuel prices continued to fall. 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 more competition with speculators for long futures positions and at somewhat unattractive 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 February 22nd.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of February 22nd.

Factors affecting the market on the period were:

During the week ended February 15th, total petroleum inventories decreased by 1.02 million barrels vs. a five year average decrease of 0.38 million barrels and vs. an expected decrease of 0.20 million barrels. Inventories decreased by 0.63 million barrels vs. the five year average. Total inventories stand at 730.4 million barrels, down from 731.4 million barrels at the end of the previous week. The five year average inventory is 709.7 million barrels, down from 710.1 million barrels at the end of the previous week.

Current inventories are 2.91% larger than the five year average down from +3.00% at the end of the previous week. Inventories versus the five year average on a percentage basis continue to decline yet remain at historically high levels. This is less negative for price and continues mitigates the effects of more speculation.

As of February 19th, the net speculative long position in petroleum futures was 351,504,000 barrels down 8,331,000 barrels (-2.32%) from the previous week. The level of speculation decreased for the first time in ten weeks and represents 48.13% of domestic inventories. Speculation is 31.57% above its one year moving average and is 14.00% below the 52 week high level. Levels have decreased but remain relatively high and roughly equivalent to levels seen in the spring of 2011 and 2012. The corresponding spot month heating oil futures price on February 19th was 318.06 cents per gallon, down 5.56 cents from 323.62 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 83.68% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 70.03% 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 243.64 cents per gallon or 74.41 cents per gallon less than current prices. The analysis would indicate that about 23.40% of current price is attributable to speculation and its underlying market rationale. The "would be" price was slightly lower 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 267 million barrels, down by roughly one 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.