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Petroleum Market Commentary - March 4, 2013

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Dollar Soars - Speculation & Prices Drop Sharply - Sequester

DIESEL:

During the week ending March 1st, the spot month heating oil futures price decreased by 17.17 cents per gallon (-5.54%) while the deferred months decreased by 8 to 16 cent per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 1.01 cent (0.34%) discount to the spot price, from a discount of 5.26 cents (1.69%) 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 March 1st, the spot month gasoline futures price decreased by 13.72 cents per gallon (-4.20%) while the deferred months decreased by 8 to 13 cents per gallon making the forward pricing curve lower and more less sloped. The one year forward price ended the week at a 39.18 cent (14.32%) discount to the spot price, from a discount of 40.84 cents (15.29%) 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 and global economy continued to show signs of improvement while some risk factors persist. Inventories on the week were smaller than expected, remain larger than historical averages but are shrinking vs. historical averages. A better economy and lower inventories keep upward pressure on prices. The US Dollar was higher which is negative for price. The stock market was higher which is positive for price. Speculation was lower on the week which was negative for price. The dollar has been driving price in the past four weeks as it has been becoming very strong especially versus the Yen and Pound. As the economy improves, the likelihood that the Fed will curtail quantitative easing sooner rather than later increases. Any pull back from QE by the fed due to a stronger economy would be very positive for the dollar and negative for petroleum prices. These financial factors are against a backdrop of fundamental market factors including US domestic crude production at 20 year highs and increasing rapidly.

Weekly US petroleum demand increased by 1.46% during the week ending February 22nd. Demand is up 1.96% vs. one year ago and is 3.66% below the five year average.

The attractiveness of making new hedges increased on the week given the lower priced environment. 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 an average level of 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 March 1st.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of March 1st.

Factors affecting the market on the period were:

During the week ended February 22nd, 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 2.78% larger than the five year average down from +2.91% at the end of the previous week. Inventories versus the five year average on a percentage basis continue to decline yet remain high. This is less negative for price.

As of February 26th, the net speculative long position in petroleum futures was 307,125,000 barrels down 44,379,000 barrels (-12.63%) from the previous week. The level of speculation decreased sharply the second week and represents 42.06% of domestic inventories. Speculation is 15.80% above its one year moving average and is 22.82% below the 52 week high level. Levels have decreased and are returning to more average levels yet remain relatively high. The corresponding spot month heating oil futures price on February 26th was 303.17 cents per gallon, down 14.89 cents from 318.06 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 83.50% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 69.72% 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 242.09 cents per gallon or 62.09 cents per gallon less than current prices. The analysis would indicate that about 20.15% of current price is attributable to speculation and its underlying market rationale. The "would be" price was about 1 cent 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 265 million barrels, down by roughly two 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.