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Petroleum Market Commentary - April 29, 2013

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Prices Lower - Inventory Higher - Speculation Lower

DIESEL:

During the week ending April 26th, the spot month heating oil futures price increased by 11.36 cents per gallon (+4.08%) while the deferred months increased by 6 to 9 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 3.80 cent (1.31%) discount to the spot price, from a premium of 0.59 cents (0.21%) and the end of the previous week.

The change in level and slope of this forward pricing curve indicates higher demand expectations and lower 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 26th, the spot month gasoline futures price increased by 6.25 cents per gallon (+2.25%) while the deferred months increased by 7 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 12.82 cent (4.74%) discount to the spot price, from a discount of 14.17 cents (5.39%) 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 US dollar was weaker on the week. Inventories on the week were lower than expectations and remain above historical averages. The stock market was higher which is negative for price. Speculation was lower on the week which is negative of price. US domestic crude production increased to a new 21 year high. Geopolitical risk with Iran and North Korea continues to be a background factor that is supportive of price.

Weekly US petroleum demand increased by 0.81% during the week ending April 19th. Demand is down by 0.87% vs. one year ago and demand is currently 3.54% below the five year average.

The attractiveness of making new hedges decreased on the week given the 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 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 26th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of April 26th.

Factors affecting the market on the period were:

During the week ended April 19th, total petroleum inventories decreased by 2.88 million barrels vs. a five year average increase of 0.64 million barrels and vs. an expected increase of 0.25 million barrels. Inventories decreased by 3.53 million barrels vs. the five year average. Total inventories stand at 721.7 million barrels, down from 724.6 million barrels at the end of the previous week. The five year average inventory is 704.8 million barrels, up from 704.2 million barrels at the end of the previous week.

Current inventories are 2.39% larger than the five year average down from +2.90% 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 23rd, the net speculative long position in petroleum futures was 209,939,000 barrels down 30,178,000 barrels (-12.89%) from the previous week. The level of speculation decreased for the third week and represents 28.26% of domestic inventories. Speculation is 18.37% below its one year moving average and is 43.32% below the 52 week high level. Speculative levels are in the lower quartile of the past year's range. The corresponding spot month heating oil futures price on April 23rd was 281.17 cents per gallon, up 0.52 cents from 280.65 cents per gallon during the previous week. It is unusual for prices to be steady given such a drop in speculation level. This indicates a strong demand for hedging at these prices.

Heating oil price and size of speculative net long position in petroleum are 79.07% correlated over the past 52 weeks (a slight increase on the week) indicating that, on a statistical basis over the past year 62.52% 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 lower level of correlation indicates that price has become more a 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 234.13 cents per gallon or 47.04 cents per gallon less than current prices. The analysis would indicate that about 16.73% 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 250 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.