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Petroleum Market Commentary - April 20, 2015

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Prices Higher - Inventory Up - Rig Count Down - Dollar Down - Spec Up

DIESEL:

During the week ending April 17th, the spot month diesel futures price increased by 11.63 cents per gallon (+6.59%) while the deferred months increased by 6 to 12 cents per gallon making the forward pricing curve higher and less positively sloped. The one year forward price ended the week at a 9.62 cent premium to the spot price, from a premium of 11.98 cents at the end of the previous week.

The change in level and slope of the diesel forward pricing curve indicates higher demand expectations and lower supplies with respect to demand. Demand includes speculative demand which was higher on the week. 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 April 17th, the spot month gasoline futures price increased by 12.26 cents per gallon (+6.78%) while the deferred months increased from 6 to 13 cents per gallon making the forward pricing curve higher and relatively steady in slope. The one year forward price ended the week at a 0.09 cent premium to the spot price, from a premium of 3.85 cents and the end of the previous week.

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

ANALYSIS:

The US dollar decreased on the week which is positive for price. Inventories on the week were higher which is negative for price. The stock market, as a proxy for demand expectations, was lower which is negative for price. Speculation was higher on the week which is positive for price. US domestic crude production was lower on the week which is positive for price. Domestic production is up 13.05% year over year.

The attractiveness of making new hedges decreased due to higher prices and higher levels of speculation. On a flat-price basis, prices remain attractive when compared to the last four years and are above the middle of where prices have been over the past four months. The market has found a price range. Production is expected to continue to outstrip demand and inventories will continue to grow into the second half of 2015 although the rate of growth of inventories has and will continue to slow. Speculation was higher giving the hedger more competition with speculators for long positions. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging may become more attractive.

DEMAND:

Weekly US petroleum demand decreased by 0.67% during the week ending April 10th. Domestic demand is up 4.29% vs. one-year ago and demand is currently 1.29% over the five year average.

PRODUCTION:

Domestic production decreased slightly on the week. The number of operating oil drilling rigs in the US continues to decline. During the week, the number of operating rigs in the US declined by 26 or 3.42%. The previous week's decline was 42 rigs. This will limit production growth and may cause sustained declines in production which would help in balancing supply and demand in the market which would support price. The market has been watching this metric very closely and the sharp downturn in the number of operating rigs has contributed to the recent price increase. While this is true, inventories continue to grow. The market is taking the steps to balance the supply and demand yet increasing production and growing inventories will keep prices low. As the rate of change in production and inventory growth decreases, the market will take this as a signal to buy and prices will firm up.

Many new wells are being drilled but not yet finished, fracked, and put into production. When prices rise, these wells could be put into production relatively quickly in response to higher prices and higher demand. This "fracklog" as it has been dubbed, will act as inventory being stored in the ground and will serve as a cap on prices in the short to medium-term.





Below is the one-year chart of spot diesel futures prices as of April 17th.



Below is the one-year chart of spot gasoline futures prices as of April 17th.

MARKET FACTORS:

: :  Inventories increasing by 1.24 million barrels while inventories were expected to increase by 3.14 million barrels on the week. The five-year average inventory increased by 1.51 million barrels. Inventories decreased vs. the five year average and vs. expectations. While inventories are large, the recent convergence current change in inventory, historical change in inventory, and expectations of change in inventory is supportive of price and indicates that the market is stabilizing and changing to correct the current over-supply situation.

: :  The market continues to be oversupplied and is showing signs of correcting the over-supply. The process of balancing supply is seen in lower rig count in the US and higher global demand expectations due to lower price. While these things have begun, US Domestic production is expected to continue to grow but perhaps at a slower pace, and inventories continue to become larger albeit at a slower pace. Any significant increase in price would cause a resumption of production growth and would curtail any growth in demand.

: :  Speculation increased to its highest level since February 10th. This on disappearing fears that storage facilities in the US would be filled to capacity which would be negative for price. Speculation is also increasing due to the general beginning of market rebalancing of supply and demand which makes the likelihood of significantly lower prices lower.

: :  Prices were again supported this past week as Al-Qaeda militants seized control of the airport in Yemen which prompted Saudi Arabia to take action against these militants. The fear here is that the situation could escalate to the point where there is actual supply disruption either due to any damage to oil infrastructure or hostilities taking place in places where oil is transported including the Straits of Hormuz and the Gulf of Aden just south of Yemen.

: :  Doubts are increasing that the Iranian nuclear deal will come to fruition. If it were to be successful, sanctions would be lifted and Iranian oil would be for sale on the global market which would increase supply and would be negative for price. In so far as it is increasingly unlikely that the deal will happen any time soon, the market does not expect Iranian crude any time soon which is supportive for price.

: :  Stock market decreasing by -0.99% on the week is negative for economic and petroleum demand expectations and prices.

: :  The US Dollar decreasing by -1.83% is positive 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.



Below is the one-year chart US stock market prices as of April 17th.



Below is the one-year chart for the US dollar index as of April 17th.



INVENTORIES:

During the week ended April 10th, total petroleum inventories increased by 1.24 million barrels vs. a five year average increase of 1.50 million barrels and vs. an expected increase of 3.14 million barrels. Inventories decreased by 0.27 million barrels vs. the five year average. Total inventories stand at 840.5 million barrels, up from 839.3 million barrels at the end of the previous week. The five year average inventory is 719.2 million barrels, up from 717.7 million barrels at the end of the previous week.

Current inventories are 16.87% higher than the five year average, down from +14.94% at the end of the previous week. Inventory levels are growing due to excess supply and low price where those who hold inventories are accumulating more which is essentially increasing a speculative long position in the market. Those who hold inventories have an incentive to do so since forward prices are higher than spot prices, holders of inventory can earn an attractive guaranteed return on their investment.



SPECULATION:

As of April 14th, the net speculative long position in petroleum futures was 224,978,000 barrels up 19,144,000 barrels (+9.30%) from the previous week. Speculation has increased by 65.80% over the past three weeks. Speculation increased for the third week in a row and represents 26.77% of domestic inventories. Speculation is 13.05% below its one year moving average. The corresponding spot month diesel futures price on April 14th was 180.17 cents per gallon, up 1.79 cents from 178.38 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 60.40% correlated over the past 52 weeks indicating that, on a statistical basis over the past year 36.48% 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 163.41 cents per gallon or 16.76 cents per gallon less than current prices. The analysis would indicate that about 9.30% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 2 cents lower on the week.

The net speculative long position has been variable over the past year ranging between 135 million and 453 million barrels with an average of about 259 million barrels, which is down about 4 million barrels on the week.

CONTACT:

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 and natural gas.