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Petroleum Market Commentary - April 22, 2013

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Prices Lower - Inventory Higher - Speculation Lower

DIESEL:

During the week ending April 19th, the spot month heating oil futures price decreased by 8.42 cents per gallon (-2.93%) while the deferred months decreased by 5 to 9 cents per gallon making the forward pricing curve lower and less negatively sloped in general while becoming staying flat over the next twelve months. The one year forward price ended the week at a 0.59 cent (0.21%) premium to the spot price, from a premium of 0.76 cents (0.26%) and the end of the previous week.

The change in level and slope of this forward pricing curve indicates lower demand expectations and higher 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 April 19th, the spot month gasoline futures price decreased by 2.94 cents per gallon (-1.05%) while the deferred months decreased by 4 to 9 cents per gallon making the forward pricing curve lower and more negatively sloped especially in the nearby months. The one year forward price ended the week at a 14.17 cent (5.39%) discount to the spot price, from a discount of 7.87 cents (2.89%) and the end of the previous week.

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

ANALYSIS:

The US dollar touched was stronger on the week. Inventories on the week were higher than expectations and remain above historical averages. The stock market was lower which is negative for price. Speculation was lower on the week which is negative of price. US domestic crude production increased by 0.38% on the week which is significant since this is a rate of 21.55% annualized increase. Geopolitical risk with Iran and North Korea continues to be a background factor that is supportive of price.

Weekly US petroleum demand increased by 1.88% during the week ending April 12th. Demand is up 0.22% vs. one year ago and is 3.08% below the five year average.

The attractiveness of making new hedges increased again on the week given the 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 less competition with speculators for long futures positions. Heating oil futures in the $2.80 - $2.90 has made hedging more advantageous depending on the goals of hedger.

Below is a one year chart of spot diesel futures prices, the proxy hedging mechanism for diesel fuel, as of April 19th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of April 19th.

Factors affecting the market on the period were:

During the week ended April 12th, total petroleum inventories increased by 0.50 million barrels vs. a five year average decrease of 0.41 million barrels and vs. an expected decrease of 0.70 million barrels. Inventories increased by 0.91 million barrels vs. the five year average. Total inventories stand at 724.6 million barrels, up from 724.1 million barrels at the end of the previous week. The five year average inventory is 704.2 million barrels, down from 704.6 million barrels at the end of the previous week.

Current inventories are 2.90% larger than the five year average up from +2.77% at the end of the previous week. Inventories versus the five year average on a percentage basis remain positive. This helps to mitigate the effects of supply disruption and decreases price volatility.

As of April 16th, the net speculative long position in petroleum futures was 234,117,000 barrels down 29,078,000 barrels (-11.05%) from the previous week. The level of speculation decreased for the second week and represents 32.31% of domestic inventories. Speculation is 7.08% below its one year moving average and is 34.94% below the 52 week high level. Speculative levels continue to be around the one-year average. The corresponding spot month heating oil futures price on April 16th was 280.65 cents per gallon, down 15.48 cents from 296.13 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 79.05% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 62.48% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has become weaker over the past several months but remains significant. This change shows a difference in the market over the past several months where, perhaps, the market is more of a function of market fundamentals of supply and demand and slightly less a function of speculation. As the level of speculation decreases, the correlation tends to decrease as well as we have seen in the past. 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 234.81 cents per gallon or 45.84 cents per gallon less than current prices. The analysis would indicate that about 16.33% of current price is attributable to speculation and its underlying market rationale. The "would be" price was about a penny lower on the week and continues to fall.

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 252 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.