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Petroleum Market Commentary - June 1, 2015

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Prices Mixed - Inventory Lower - Rig Count Lower - Dollar Up - Production Up

DIESEL:

During the week ending May 29th, the spot month diesel futures price increased by 0.28 cents per gallon (+0.14%) while the deferred months decreased by 0 to 1 cents per gallon making the forward pricing curve steady and less positively sloped. The one year forward price ended the week at a 5.67 cent premium to the spot price, from a premium of 7.06 cents at the end of the previous week.

The change in level and slope of the diesel forward pricing curve indicates steady 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 May 29th, the spot month gasoline futures price increased by 3.19 cents per gallon (+1.55%) while the deferred months increased from 0 to 2 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 12.25 cent discount to the spot price, from a discount of 8.90 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 increased on the week which is negative for price. Inventories on the week were lower which is positive 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 higher on the week to a new all-time high which is negative for price. Domestic production is up 12.91% year over year.

The attractiveness of making new hedges was relatively unchanged on the week with relatively steady prices and little change in speculation levels.

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 1.26% during the week ending May 22nd. Domestic demand is up 3.46% vs. one-year ago and demand is currently 3.85% over the five year average.

PRODUCTION:

Domestic production surged to a new all-time high on the week showing that despite the lower rig count and lower prices, domestic production continues to grow. 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 13 or 1.97%. The previous week's decline was 1 rig. This will limit production growth and is beginning to show stabilization and decline in production which is helping to balance 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.

Oil producers are learning how to cut costs and are getting better and finding oil more cheaply which brings down the marginal cost of production that, in turn, acts as a cap on oil prices. Also, the ability to quickly increase production in response to higher prices is improving. If supply can quickly respond to price, this increases the price elasticity of supply which would be a sea change in the fundamentals of the global oil market. Production that can quickly respond to price acts more like inventory than it does production. US domestic production and rig count will become increasingly more important to the market. Inventory is also very important as has always been true. But just because US domestic inventories are decreasing from their peaks, doesn't mean that there isn't more oil coming out of the ground globally than is going up in smoke on a daily basis.





Below is the one-year chart of spot diesel futures prices as of May 29th.



Below is the one-year chart of spot gasoline futures prices as of May 29th.

MARKET FACTORS:

: :  Inventories continue to decrease from the recent high levels set on April 24th. Inventories decreased by 5.00 million barrels while inventories were expected to decrease by 2.91 million barrels on the week. The five-year average inventory increased by 0.60 million barrels. Inventories decreased vs. the five year average and vs. expectations. While inventories are large, we are seeing the first signs of market balancing with the overall reduction of inventory for the first time in six months. This slowing or stopping inventories from growing further will support price. However, while the overall level of inventories will keep prices relatively low in the short to medium-term, the global market continues to be oversupplied by 1.5 to 2.0 million barrels per day which will keep downward pressure on prices.

: :  Stock market decreasing by -0.88% on the week is generally negative for economic and petroleum demand expectations and prices.

: :  The US Dollar increasing by +0.93% is negative 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 May 29th.



Below is the one-year chart for the US dollar index as of May 29th.



INVENTORIES:

During the week ended May 22nd, total petroleum inventories decreased by 5.00 million barrels vs. a five year average increase of 0.60 million barrels and vs. an expected decrease of 2.91 million barrels. Inventories decreased by 5.60 million barrels vs. the five year average. Total inventories stand at 828.8 million barrels, down from 833.8 million barrels at the end of the previous week. The five year average inventory is 74.48 million barrels, up from 723.8 million barrels at the end of the previous week.

Current inventories are 14.41% higher than the five year average, down from +15.20% at the end of the previous week.



SPECULATION:

As of May 26th, the net speculative long position in petroleum futures was 263,868,000 barrels, up 692,000 barrels (+0.26%) from the previous week. Speculation increased for the first time in three weeks and represents 31.83% of domestic inventories. Speculation is 9.27% above its one year moving average. The corresponding spot month diesel futures price on May 26th was 190.02 cents per gallon, down 2.90 cents from 192.92 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 43.50% correlated over the past 52 weeks indicating that, on a statistical basis over the past year 18.93% 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 167.14 cents per gallon or 22.88 cents per gallon less than current prices. The analysis would indicate that about 12.04% of current price is attributable to speculation and its underlying market rationale. This "would be" price was higher by slightly more than 1 cent 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 241 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.