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Petroleum Market Commentary - May 5, 2014

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Prices Lower - Inventory Higher - Speculation to New All-Time High

DIESEL:

During the week ending May 2nd, the spot month diesel futures price decreased by 5.86 cents per gallon (-1.97%) while the deferred months decreased by 1 to 5 cents making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 7.53 cent (2.58%) discount to the spot price, from a discount of 9.70 cents (3.25%) and the end of the previous week.

The change in level and slope of the diesel forward pricing curve indicates lower demand expectations and higher supplies with respect to demand. Demand includes speculative demand. 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.

Below is a one week chart of the diesel forward pricing curve as of May 2nd.

GASOLINE:

During the week ending May 2nd, the spot month gasoline futures price decreased by 8.21 cents per gallon (-2.71%) while the deferred months decreased by 1 to 7 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 20.91 cent (7.64%) discount to the spot price, from a discount of 29.44 cents (10.59%) 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.

Below is a one week chart of the gasoline forward pricing curve as of May 2nd.

ANALYSIS:

The US dollar was lower 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 to a new all-time high which is positive for price. US domestic crude production was slightly lower on the week which is positive for price.

Below are charts of three year crude production and avg. vs. five year demand as of April 25th.


Weekly US petroleum demand increased by 4.42% during the week ending April 25th. Demand is up 0.65% vs. one-year ago and demand is currently 1.00% below the five year average.

The attractiveness of making new hedges increased slightly on the week as prices were lower. Higher speculation levels made new hedging unattractive since new hedging should seek to involve a minimum amount of competition with speculators for long futures positions. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging will become more attractive.

Below are the one year charts of spot diesel and spot gasoline futures prices as of May 2nd.


MARKET FACTORS:

: :  Inventories increasing by 5.20 million barrels while inventories were expected to increase by 1.35 million barrels on the week. The five year average inventory increased by 2.54 million barrels. Inventories increased vs. the five year average and vs. expectations.

: :  Tensions in Ukraine continue to sustain speculation levels which is supportive of price. During the week, two Ukrainian helicopters were shot down by rebels increasing the tensions there and increasing the likelihood that the situation in Ukraine could become larger and wider such that it would disrupt the flow of petroleum.

: :  Speculation rose to a new all-time high level while inventories increased significantly.

: :  US domestic economic factors including:

: :  The US Stock market decreasing by 0.94% on the week which is negative for economic and petroleum demand expectations and prices.

: :  The US Dollar decreasing by 0.29% on the week which 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.

INVENTORIES:

During the week ended April 25th, total petroleum inventories increased by 5.20 million barrels vs. a five year average increase of 2.54 million barrels and vs. an expected increase of 1.35 million barrels. Inventories increased by 2.66 million barrels vs. the five year average. Total inventories stand at 725.4 million barrels, up from 720.2 million barrels at the end of the previous week. The five year average inventory is 725.0 million barrels, up from 722.5 million barrels at the end of the previous week.

Current inventories are 0.05% larger than the five year average up from -0.32% at the end of the previous week. Inventories versus the five year average on a percentage basis are positive for the first time since December 27th which shows that inventories continue to be healthy and have replenished themselves after the extraordinary winter heating season. The five year average inventory has grown over the past five years and it has become increasingly difficult for current inventories to surpass the five year average. Current inventories will be closer to the five year average and not as high compared to it. Also, increased production in the U.S. over the past three years diminishes the need for larger inventories since production is geographically closer to consumption and the risk of disruption and disruption due to geopolitical events is lower.

Below is a one year chart of average petroleum inventory as of April 25th.

SPECULATION:

Why are speculation levels at all-time highs and diesel prices are only around $3.00 per gallon and not $3.50 or $4.00? Furthermore, what will happen to prices when speculation returns to a more normal level? Will prices fall creating a low-price hedging opportunity?

As of April 29th, the net speculative long position in petroleum futures was 448,666,000 barrels up 5,550,000 barrels (+1.25%) from the previous week. Speculation increased for the fifth week in a row to a new all-time high level and represents 61.85% of domestic inventories. Speculation is 33.43% above its one year moving average and is at a new 52-week high. The corresponding spot month diesel futures price on April 29th was 297.01 cents per gallon, down 1.56 cents from 298.70 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 57.15% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 32.67% 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 276.75 cents per gallon or 20.25 cents per gallon less than current prices. The analysis would indicate that about 6.82% of current price is attributable to speculation and its underlying market rationale. The "would be" price was up by about 2 cents on the week.

The net speculative long position has been variable over the past year ranging between 225 million and 449 million barrels with an average of about 336 million barrels, which up about 4 million barrels on the week.

The graph below is three year history of speculative position levels as of April 29th.

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, natural gas, and electricity on a nationwide basis.