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Petroleum Market Commentary - March 10, 2014

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Spot Prices Steady - Inventories Higher - Record Speculation

DIESEL:

During the week ending March 7th, the spot month diesel futures price decreased by 0.42 cents per gallon (-0.14%) while the deferred months changed by -2 to +1 cents making the forward pricing curve nearly unchanged in level and slope. The one year forward price ended the week at a 13.82 cent (4.59%) discount to the spot price, from a discount of 18.61 cents (6.02%) 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 higher 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 March 7th.

GASOLINE:

During the week ending March 7th, the spot month gasoline futures price decreased by 0.36 cents per gallon (-0.12%) while the deferred months decreased by 0 to 2 cents per gallon making the forward pricing curve lower and more negatively sloped. The one year forward price ended the week at a 22.63 cent (8.24%) discount to the spot price, from a discount of 19.33 cents (7.44%) and the end of the previous week.

Below is a one week chart of the gasoline forward pricing curve as of March 7th.

ANALYSIS:

The US dollar was slightly higher on the week which is negative for price. Inventories on the week were higher which is negative for price. The stock market, as a proxy for demand expectations, was higher which is positive for price. Speculation was higher on the week which is positive for price. US domestic crude production was higher on the week which is negative for price.

Below are charts of three year crude production and avg. vs. five year demand as of February 28th.


Weekly US petroleum demand increased by 0.04% during the week ending February 28th. Demand is down 0.82% vs. one-year ago and demand is currently 2.61% below the five year average.

The attractiveness of making new hedges was relatively unchanged on the week as prices were steady and speculation levels increased slightly to new all-time high levels. Higher speculation causes hedging to be less attractive since it 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 March 7th.


MARKET FACTORS:

: :  Inventories increasing by 1.24 million barrels while inventories were expected to decrease by 1.5 million barrels on the week. The five year average inventory decreased by 2.59 million barrels. Inventories increased vs. the five year average and vs. expectations.

: :  Tensions between Russia and Ukraine causing uncertainty in the market and increasing the possibility of supply disruption. This is supportive of speculative activity and price.

: :  Stronger than expected US February manufacturing activity as reported by the Institute of Supply Management. This is positive for economic expectations, petroleum demand expectations, and price.

: :  Stronger than expected US January construction spending indicating strength in the construction and housing sector which is, in turn, supportive of economic growth expectations, petroleum demand growth expectations, and price.

: :  US weekly unemployment claims decreased to a three month low indicating continued strength in the labor market which is positive for the economy, petroleum demand and price.

: :  Weaker than expected US January factory orders indicating weakness in the domestic manufacturing sector which is negative for petroleum demand expectations and price.

: :  Stronger than expected increase in US February payrolls indicating that the economy created more jobs than expected in February than was expected. This is a positive sign for the economy, petroleum demand expectations, and price.

: :  US weekly unemployment claims decreased to a three month low indicating continued strength in the labor market which is positive for the economy, petroleum demand and price.

: :  The US Dollar increasing by 0.04 on the week which is negative 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 28th, total petroleum inventories increased by 1.24 million barrels vs. a five year average decrease of 2.59 million barrels and vs. an expected decrease of 1.50 million barrels. Inventories increased by 3.83 million barrels vs. the five year average. Total inventories stand at 707.3 million barrels, up from 706.1 million barrels at the end of the previous week. The five year average inventory is 721.7 million barrels, down from 724.3 million barrels at the end of the previous week.

Current inventories are 2.00% smaller than the five year average up from -2.52% 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 28th.

SPECULATION:

As of March 4th, the net speculative long position in petroleum futures was 447,550,000 barrels up 7,728,000 barrels (+1.76%) from the previous week. Speculation increased for the sixth week in a row to new all-time highs and represents 63.28% of domestic inventories. Speculation is 43.80% above its one year moving average and set a new high on the week. The corresponding spot month heating oil futures price on March 4th was 304.07 cents per gallon, down 6.36 cents from 310.43 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 78.50% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 61.62% 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 265.35 cents per gallon or 38.72 cents per gallon less than current prices. The analysis would indicate that about 12.73% of current price is attributable to speculation and its underlying market rationale. The "would be" price was up by about 0.75 cents on the week.

The net speculative long position has been variable over the past year ranging between 203 million and 448 million barrels with an average of about 311 million barrels, which up about 3 million barrels on the week.

The graph below is three year history of speculative position levels as of March 4th.

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.