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Petroleum Market Commentary - April 1, 2013

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Prices Down - Speculation Steady - Inventories Lower

DIESEL:

During the week ending March 29th, the spot month heating oil futures price increased by 3.09 cents per gallon (+1.07%) while the deferred months increased by 5 to 8 cents per gallon making the forward pricing curve higher and more negatively sloped except for the spot month. The one year forward price ended the week at a 6.64 cent (2.28%) premium to the spot price, from a premium of 3.22 cents (1.12%) 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 higher demand expectations and a decrease in supplies with respect to demand. Demand includes speculative demand which increased 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 29th, the spot month gasoline futures price increased by 4.29 cents per gallon (+1.40%) while the deferred months increased by 5 to 9 cents per gallon making the forward pricing curve higher and less negatively sloped. The one year forward price ended the week at a 23.08 cent (8.03%) discount to the spot price, from a discount of 27.20 cents (9.750.55%) and the end of the previous week.

The change in level and shape of this forward pricing curve indicates higher demand expectations and higher inventory levels with respect to supply and demand.

ANALYSIS:

The situation in Cyprus improved but continued to concern the market. The US dollar increased to a 7.75 month high which is negative for price. 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 higher which is positive for price. Speculation was higher on the week which is supportive of price. US domestic crude production increased slightly on the week. Geopolitical risk with Iran, North Korea, and Syria continues to support price.

Weekly US petroleum demand increased by 6.24% during the week ending March 22nd. Demand is up 1.24% vs. one year ago and is 4.08% below the five year average.

The attractiveness of making new hedges decreased on the week given the slightly higher 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 relatively higher level of competition with speculators for long futures positions. 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 29th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of March 29th.

Factors affecting the market on the period were:

During the week ended March 22nd, total petroleum inventories decreased by 2.85 million barrels vs. a five year average increase of 1.19 million barrels and vs. an expected decrease of 0.55 million barrels. Inventories decreased by 4.04 million barrels vs. the five year average. Total inventories stand at 722.41 million barrels, down from 725.26 million barrels at the end of the previous week. The five year average inventory is 707.0 million barrels, up from 705.8 million barrels at the end of the previous week.

Current inventories are 2.17% larger than the five year average down from +2.75% 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 26th, the net speculative long position in petroleum futures was 277,150,000 barrels up 19,468,000 barrels (+7.56%) from the previous week. The level of speculation increased for the second time in two weeks and represents 35.67% of domestic inventories. Speculation is 8.38% above its one year moving average and is 22.98% below the 52 week high level. Levels have increased and remain at average levels. The corresponding spot month heating oil futures price on March 26th was 288.13 cents per gallon, up 1.72 cents from 286.41 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 80.55% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 64.88% 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 236.26 cents per gallon or 51.87 cents per gallon less than current prices. The analysis would indicate that about 18.11% of current price is attributable to speculation and its underlying market rationale. The "would be" price was about 1 cent lower on the week and continues to decrease.

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 256 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.