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Petroleum Market Commentary - March 18, 2013

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Prices Down - Dollar Lower - Speculation Drops - Inventories Lower

DIESEL:

During the week ending March 15th, the spot month heating oil futures price decreased by 3.59 cents per gallon (-1.21%) while the deferred months ranged from up 1 cent to down 3 cents per gallon making the forward pricing curve stable and less negatively sloped. The one year forward price ended the week at a 1.96 cent (0.67%) premium to the spot price, from a discount of 1.07 cents (0.36%) and the end of the previous week. This premium is mostly due to the change in futures contract specifications from heating oil to ultra-low sulfur diesel starting with the May 2013 contract.

The change in level and slope of this forward pricing curve indicates stable demand expectations and an increase in supplies with respect to demand. Demand includes speculative demand which decreased 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 15th, the spot month gasoline futures price decreased by 3.97 cents per gallon (-1.24%) while the deferred months ranged from up 3 to down 3 cents per gallon making the forward pricing curve stable and less negatively sloped. The one year forward price ended the week at a 30.19 cent (10.55%) discount to the spot price, from a discount of 36.39 cents (12.82%) and the end of the previous week.

The change in level and shape of this forward pricing curve indicates stable 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 in line with expectations and remain larger than historical averages. A better economy keeps upward pressure on prices since a more robust economy increases demand and demand expectations. The US Dollar was lower which is positive for price. The stock market was higher which is positive for price. Speculation was lower on the week which is negative for price. 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 20.5 year highs and increasing rapidly, lower demand expectations globally, and geopolitical risk.

Weekly US petroleum demand increased by 1.65% during the week ending March 8th. Demand is up 1.01% vs. one year ago and is 3.97% below the five year average.

The attractiveness of making new hedges increased slightly on the week given the slightly lower price 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. Heating oil futures in the $2.80 - $2.90 level will trigger additional hedging and depending on the goals of hedging, hedging further forward in time at lower prices is appropriate.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of March 15th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of March 15th.

Factors affecting the market on the period were:

During the week ended March 8th, total petroleum inventories decreased by 0.86 million barrels vs. a five year average increase of 0.06 million barrels and vs. an expected decrease of 0.90 million barrels. Inventories decreased by 0.93 million barrels vs. the five year average. Total inventories stand at 728.7 million barrels, down from 729.6 million barrels at the end of the previous week. The five year average inventory is 707.3 million barrels, up from 707.2 million barrels at the end of the previous week.

Current inventories are 3.03% larger than the five year average down from +3.16% at the end of the previous week. Inventories versus the five year average on a percentage basis remain high and steady. This helps to mitigate the effects of supply disruption and decreases price volatility.

As of March 12th, the net speculative long position in petroleum futures was 250,976,000 barrels down 16,027,000 barrels (-6.00%) from the previous week. The level of speculation decreased for the fourth week and represents 34.44% of domestic inventories. Speculation is 3.45% below its one year moving average and is 34.26% below the 52 week high level. Levels have decreased and are returning to more average levels. The corresponding spot month heating oil futures price on March 12th was 294.84 cents per gallon, down 2.46 cents from 297.30 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 83.10% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 69.06% 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 238.76 cents per gallon or 56.08 cents per gallon less than current prices. The analysis would indicate that about 19.02% of current price is attributable to speculation and its underlying market rationale. The "would be" price was about 2 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 260 million barrels, down by roughly three 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.