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Petroleum Market Commentary - March 3, 2014

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Prices Lower - Inventories Lower - All-Time High Speculation

DIESEL:

During the week ending February 28th, the spot month diesel futures price decreased by 0.99 cents per gallon (-0.32%) while the deferred months changed by -3 to +1 cents making the forward pricing stable and generally less negatively sloped. The one year forward price ended the week at an 18.61 cent (6.02%) discount to the spot price, from a discount of 17.87 cents (5.77%) and the end of the previous week.

The change in level and slope of the diesel forward pricing curve indicates slightly lower demand expectations near-term and slightly lower supplies with respect to demand. 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.

Below is a one week chart of the diesel forward pricing curve as of February 28th.

GASOLINE:

During the week ending February 28th, the spot month gasoline futures price decreased by 4.35 cents per gallon (-1.54%) while the deferred months increased by -3 to +1 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 19.33 cent (7.44%) discount to the spot price, from a discount of 23.74 cents (9.15%) 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.

Below is a one week chart of the gasoline forward pricing curve as of February 28th.

ANALYSIS:

The US dollar was lower on the week which is positive for price. Inventories on the week were lower which is positive for price. The stock market, as a proxy for demand expectations, was higher which is positive for price. Speculation increased for the fifth week in a row to new all-time high levels which is positive for price. US domestic crude production was lower on the week which is positive for price.

Below are charts of three year crude production and avg. vs. five year demand as of February 21st.


Weekly US petroleum demand decreased by 2.28% during the week ending February 21st. Demand is up 0.61% vs. one-year ago and demand is currently 2.09% below the five year average. This is the lowest level versus the five year average since August 30, 2013.

The attractiveness of making new hedges was generally unchanged on the week as prices were relatively steady. However, significantly higher speculation caused hedging to be less attractive on the week since hedging would involve an increased level of competition with speculators for long positions which is disadvantageous for the long-hedger. 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 are the one year charts of spot diesel and spot gasoline futures prices as of February 28th.


MARKET FACTORS:

: :  Inventories decreasing by 2.40 million barrels while inventories were expected to decrease by 2.00 million barrels on the week. The five year average inventory increased by 0.13 million barrels. Inventories decreased vs. the five year average and vs. expectations.

: :  Fed Chair Yellen indicated that the tapering of QE3 would remain on pace meaning that the Fed would be less likely to taper less if the economy is slower than expected. This is potentially negative for economic expectations, petroleum demand expectations and price.

: :  An unexpected increase in German business confidence for February to a 2.5 year high level indicates strength in the German economy which is positive for German petroleum demand expectations and price.

: :  US economic factors including:

: :  The US Stock market increasing by 1.26% on the week which is positive for economic and petroleum demand expectations and prices.

: :  The US Dollar decreasing by 0.68 on the week which is positive for petroleum price. Commodities are used as a hedge against inflation and against a falling dollar. A stronger dollar reduces the relative demand for commodities for this purpose and prices decrease accordingly. Conversely, a weaker dollar increases relative demand for commodities and prices increase.

INVENTORIES:

During the week ended February 21st, total petroleum inventories decreased by 2.40 million barrels vs. a five year average increase of 0.13 million barrels and vs. an expected decrease of 2.00 million barrels. Inventories decreased by 2.53 million barrels vs. the five year average. Total inventories stand at 706.1 million barrels, down from 708.5 million barrels at the end of the previous week. The five year average inventory is 724.3 million barrels, up from 724.2 million barrels at the end of the previous week.

Current inventories are 2.52% smaller than the five year average down from -2.17% at the end of the previous week. Inventories versus the five year average on a percentage basis are negative for the 8th week. The five year average inventory has grown over the past five years and it has become increasingly difficult for current inventories to surpass the five year average. Current inventories will be closer to the five year average and not as high compared to it. Also, increased production in the U.S. over the past three years diminishes the need for larger inventories since production is closer to consumption and the risk of disruption is lower.

Below is a one year chart of average petroleum inventory as of February 21st.

SPECULATION:

As of February 25th, the net speculative long position in petroleum futures was 439,822,000 barrels up 33,021,000 barrels (+8.12%) from the previous week. Speculation increased for the fifth week in a row to new all-time highs and represents 62.29% of domestic inventories. Speculation is 42.91% above its one year moving average and is at a new 52-week high. The corresponding spot month heating oil futures price on February 25th was 310.43 cents per gallon, up 0.26 cents from 310.17 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 79.28% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 62.85% of the price movement of diesel fuel is explained by changes in levels of speculation. 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 264.09 cents per gallon or 46.34 cents per gallon less than current prices. The analysis would indicate that about 14.93% of current price is attributable to speculation and its underlying market rationale. The "would be" price was up by about 0.50 cents on the week.

The net speculative long position has been variable over the past year ranging between 203 million and 440 million barrels with an average of about 308 million barrels, which up about 3 million barrels on the week.

The graph below is three year history of speculative position levels as of February 25th.

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.