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Petroleum Market Commentary - June 30, 2014

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Still Iraq - Prices Lower - Inventory Higher - Speculation Record High

DIESEL:

During the week ending June 27th, the spot month diesel futures price decreased by 5.36 cents per gallon (-1.76%) while the deferred months changed by up 1 cent to down 5 cents making the forward pricing curve mostly lower and less negatively sloped. The one year forward price ended the week at a 4.87 cent discount to the spot price, from a discount of 7.74 cents at 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 which was higher on the week to a new all-time high level. 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 June 27th.

GASOLINE:

During the week ending June 27th, the spot month gasoline futures price decreased by 2.89 cents per gallon (-0.92%) while the deferred months decreased by 1 to 2 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 24.70 cent discount to the spot price, from a discount of 26.21 cents 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 June 27th.

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 which is positive for price. US domestic crude production decreased on the week which is positive for price.

DEMAND:

Weekly US petroleum demand increased by 1.35% during the week ending June 20h. Demand is down 0.15% vs. one-year ago and demand is currently 2.11% below the five year average.

The attractiveness of making new hedges increased on the week as prices decreased. But speculation at all-time high levels causes a wait-and-see posture as lower prices would be expected. 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 is a chart of three-year domestic crude production as of June 20th.



Below is a chart of average vs. five-year demand as of June 20th.



Below is the one-year chart of spot diesel futures prices as of June 27th.



Below is the one-year chart of spot gasoline futures prices as of June 27th.

MARKET FACTORS:

: :  Inventories increasing by 3.63 million barrels while inventories were expected to increase by 1.00 million barrels on the week. The five-year-average inventory increased by 0.38 million barrels. Inventories increased vs. the five year average and vs. expectations.

: :  The conflict in Iraq that caused a sharp price spike on Thursday the 12th is becoming less of a threat to the flow of oil from the southern regions of Iraq. As Iraqi forces regain control of borders with Syria and Jordan, the disruption of the flow of oil has become less likely and prices have reacted accordingly.

: :  Saudi Arabia announced that it will increase production if need be to meet any increases in global petroleum demand and/or disruptions or decreases in supply. This helps to mitigate the overall level of risk and volatility in the petroleum market and is generally negative for price. The promise of increased Saudi production will also improve the opportunities for hedging at attractive prices.

: :  The US will allow the export of crude oil after a 41 year ban. This is not a wholesale lift of the ban and is limited for the time being. By allowing export of American crude, the global petroleum system will be made more efficient and domestic production will be allowed to grow at a faster pace. Refineries will be less rewarded as they will need to compete with foreign concerns for American crude. Shorter term, this may have the effect of increased prices but longer term, this is neutral to negative for price as it will incent and reward increased American production thus increasing global supply and mitigating prices.

: :  US economic factors including:

: :  Global economic factors including:

: :  The US Stock market decreasing by 0.06% on the week which is negative for economic and petroleum demand expectations and prices.

: :  The US Dollar decreasing by 0.25% 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 June 20th, total petroleum inventories increased by 3.63 million barrels vs. a five year average increase of 0.38 million barrels and vs. an expected increase of 1.00 million barrels. Inventories increased by 3.25 million barrels vs. the five year average. Total inventories stand at 723.6 million barrels, up from 720.0 million barrels at the end of the previous week. The five year average inventory is 725.1 million barrels, up from 724.7 million barrels at the end of the previous week.

Current inventories are 0.20% lower than the five year average up from -0.65% at the end of the previous week. For the sixth week, inventories versus the five year average on a percentage basis are negative showing that inventories continue to be steady vs. historical averages. 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. In this case, "risk adjusted" inventory is higher.

Below is the chart of current inventory as a percentage of the five year average as of June 20th.



Below is the chart of current inventory vs. the five year average as of June 20th.

SPECULATION:

As of June 24th, the net speculative long position in petroleum futures was 452,252,000 barrels up 6,875,000 barrels (+1.54%) from the previous week. Speculation increased on the week and represents 62.50% of domestic inventories. Speculation is 24.45% above its one year moving average and is at a new 52-week high set this week. The corresponding spot month diesel futures price on June 24th was 304.16 cents per gallon, up 2.36 cents from 301.80 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 22.74% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 5.17% 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 289.48 cents per gallon or 14.68 cents per gallon less than current prices. The analysis would indicate that about 4.82% of current price is attributable to speculation and its underlying market rationale. The "would be" price was up two cents on the week.

The net speculative long position has been variable over the past year ranging between 246 million and 453 million barrels with an average of about 363 million barrels, which up about 4 million barrels on the week.

The graph below is three year history of speculative position levels as of June 24th.

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.