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Petroleum Market Commentary - July 1, 2013

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Prices Mixed - Inventory Higher - Speculation Sharply Lower

DIESEL:

During the week ending June 28th, the spot month heating oil futures price increased by 3.57 cents per gallon (+1.26%) while the deferred months increased by 2 to 3 cents per gallon making the forward pricing curve slightly higher and generally unchanged in slope. The one year forward price ended the week at a 5.95 cent (2.07%) discount to the spot price, from a discount of 4.35 cents (1.53%) and the end of the previous week.

The change in level and slope of this forward pricing curve indicates higher demand expectations and steady 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 June 28th, the spot month gasoline futures price decreased by 0.97 cents per gallon (-0.35%) while the deferred months varied between +3 and -3 cents from the previous week's close. This made the forward pricing curve generally unchanged in level and less negatively sloped. The one year forward price ended the week at an 8.55 cent (3.21%) discount to the spot price, from a discount of 10.56 cents (3.98%) and the end of the previous week.

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

ANALYSIS:

The US dollar was higher on the week which is negative for price. Inventories on the week were higher and remain above historical averages. This is negative for price. The stock market, as a proxy for demand expectations, was lower which is negative for price. Speculation was lower on the week which is negative of price. US domestic crude production continues to be strong and increased on the week which is negative for price. Geopolitical risk continues to be a background factor that is supportive of price.


Weekly US petroleum demand increased by 2.97% during the week ending June 21st. Demand is down by 1.60% vs. one year ago and demand is currently 2.93% below the five year average.

The attractiveness of making new hedges was relatively unchanged on the week given the slightly higher price environment and lower speculation. Speculation was lower on the week indicating that new hedges would require less competition with market speculation. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging will become more attractive. Diesel and gasoline futures prices in the current price range have made hedging more advantageous depending on the goals of hedger.

Below is a one year chart of spot diesel futures prices as of June 28th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of June 28th.

Factors affecting the market on the period were:

During the week ended June 21st, total petroleum inventories increased by 5.24 million barrels vs. a five year average increase of 0.03 million barrels and vs. an expected increase of 0 million barrels. Inventories increased by 5.21 million barrels vs. the five year average. Total inventories stand at 742.7 million barrels, up from 737.5 million barrels at the end of the previous week. The five year average inventory is 702.5 million barrels, up from 702.5 million barrels at the end of the previous week.

Current inventories are 5.72% larger than the five year average up from +4.98% 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 June 25th, the net speculative long position in petroleum futures was 240,528,000 barrels down 55,303,000 barrels (-18.69%) from the previous week. The level of speculation decreased for the first time in three weeks and represents 32.39% of domestic inventories. Speculation is 5.15% above its one year moving average and is 33.16% below the 52 week high level. Speculative levels returned to near the middle of the past year's range. The corresponding spot month heating oil futures price on June 25th was 285.84 cents per gallon, down 10.33 cents from 296.17 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 73.14% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 53.50% of the price movement of diesel fuel is explained by changes in levels of speculation. This statistical relationship continues to become weaker and remains significant. 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 247.89 cents per gallon or 37.95 cents per gallon less than current prices. The analysis would indicate that about 13.28% of current price is attributable to speculation and its underlying market rationale. The "would be" price was up about 4.0 cents on the week.

The net speculative long position has been variable over the past year ranging between 178 million and 360 million barrels with an average of about 254 million barrels, which was an increase of about 2 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.