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Petroleum Market Commentary - March 25, 2013

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Prices Down - Speculation Steady - Inventories Lower

DIESEL:

During the week ending March 22nd, the spot month heating oil futures price decreased by 5.48 cents per gallon (-1.86%) while the deferred months decreased by 2 to 6 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 3.22 cent (1.12%) premium to the spot price, from a premium of 1.96 cents (0.67%) 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 lower 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 22nd, the spot month gasoline futures price decreased by 10.13 cents per gallon (-3.20%) while the deferred months decreased by 6 to 9 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 27.20 cent (9.75%) discount to the spot price, from a discount of 30.16 cents (10.55%) 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 situation in Cyprus roiled global markets and made the US dollar increase as a safe haven currency. These things were negative for petroleum prices as the general sentiment was "risk off". Inventories on the week were lower than expectations and remain larger than historical averages. The US Dollar was higher which is negative for price. The stock market was lower which is negative for price. Speculation was higher on the week which is supportive of price. US domestic crude production decreased slightly from its 20.5 year highs. Geopolitical risk with Iran, North Korea, and Syria continues to support price.

Weekly US petroleum demand decreased by 4.47% during the week ending March 15th. Demand is up 0.91% vs. one year ago and is 3.27% 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 a low 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 22nd.

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

Factors affecting the market on the period were:

During the week ended March 15th, total petroleum inventories decreased by 3.46 million barrels vs. a five year average decrease of 1.47 million barrels and vs. an expected decrease of 2.00 million barrels. Inventories decreased by 1.99 million barrels vs. the five year average. Total inventories stand at 725.26 million barrels, down from 728.7 million barrels at the end of the previous week. The five year average inventory is 705.8 million barrels, down from 707.3 million barrels at the end of the previous week.

Current inventories are 2.75% larger than the five year average down from +3.03% 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 19th, the net speculative long position in petroleum futures was 257,682,000 barrels up 6,706,000 barrels (+2.67%) from the previous week. The level of speculation increased for the first time in five weeks and represents 35.53% of domestic inventories. Speculation is 0.04% above its one year moving average and is 31.12% below the 52 week high level. Levels have decreased and remain at average levels. The corresponding spot month heating oil futures price on March 19th was 286.41 cents per gallon, down 8.43 cents from 294.84 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 82.06% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 67.34% 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 237.29 cents per gallon or 49.12 cents per gallon less than current prices. The analysis would indicate that about 17.15% 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 258 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.