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Petroleum Market Commentary - July 7, 2014

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

DIESEL:

During the week ending July 4th, the spot month diesel futures price decreased by 7.51 cents per gallon (-2.50%) while the deferred months decreased by 2 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 2.19 cent discount to the spot price, from a discount of 4.87 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. 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 July 4th.

GASOLINE:

During the week ending July 4th, the spot month gasoline futures price decreased by 5.44 cents per gallon (-1.77%) while the deferred months decreased by 2 to 5 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 22.82 cent discount to the spot price, from a discount of 24.70 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 July 4th.

ANALYSIS:

The US dollar was higher 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 higher which is positive for price. Speculation was lower on the week which is negative for price. US domestic crude production decreased on the week which is positive for price.

DEMAND:

Weekly US petroleum demand increased by 3.33% during the week ending June 27h. Demand is down 1.16% vs. one-year ago and demand is currently 2.58% below the five year average.

The attractiveness of making new hedges increased on the week as prices and speculation both decreased. 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 27th.



Below is a chart of average vs. five-year demand as of June 27th.



Below is the one-year chart of spot diesel futures prices as of July 4th.



Below is the one-year chart of spot gasoline futures prices as of July 4th.

MARKET FACTORS:

: :  Inventories decreasing by 3.42 million barrels while inventories were expected to decrease by 2.50 million barrels on the week. The five-year-average inventory decreased by 4.39 million barrels. Inventories increased vs. the five year average and vs. decreased vs. expectations.

: :  Increased OPEC production by 278,000 barrels per day to OPEC's highest level in four months. This increase in supply is negative for price and lessens the price risk associated with geopolitical events that may disrupt the supply of oil.

: :  Reduced concern regarding Iraq as the turmoil in that country seems to be contained in the non-oil rich regions in the south. The risk of supply disruption from the situation there has all but evaporated.

: :  Hurricane Arthur's movement along the east coast has decreased expectations of holiday travel activities which is negative for gasoline demand in the very short-term. This expectation is reflected in the decreased level of speculation and is negative for price.

: :  Libyan production is rapidly returning to normal as an agreement has been struck with the rebels who have blockaded the ports in that country for a year. Libya is an important part of the equation since it directly supplies Europe. This keeps European supplies steady and European prices lower. This helps US domestic prices since there is less demand in Europe (because supplies are higher) for gasoline and diesel refined in the US causing price for US refined product to decrease and pushing down the price of domestic crude in the process.

: :  The US Stock market increasing by 1.25% on the week which is positive for economic and petroleum demand expectations and prices.

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

INVENTORIES:

During the week ended June 27th, total petroleum inventories decreased by 3.42 million barrels vs. a five year average decrease of 4.39 million barrels and vs. an expected decrease of 2.50 million barrels. Inventories increased by 0.97 million barrels vs. the five year average. Total inventories stand at 720.2 million barrels, down from 723.6 million barrels at the end of the previous week. The five year average inventory is 720.7 million barrels, down from 725.1 million barrels at the end of the previous week.

Current inventories are 0.07 lower than the five year average up from -0.20% at the end of the previous week. For the seventh week, inventories versus the five year average on a percentage basis are only slightly 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 27th.



Below is the chart of current inventory vs. the five year average as of June 27th.

SPECULATION:

As of July 1st, the net speculative long position in petroleum futures was 436,018,000 barrels down 16,234,000 barrels (-3.59%) from the previous week. Speculation decreased on the week and represents 60.54% of domestic inventories. Speculation is 18.96% above its one year moving average. The corresponding spot month diesel futures price on July 1st was 297.82 cents per gallon, down 6.34 cents from 304.16 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 19.06% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 3.63% 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 291.22 cents per gallon or 6.60 cents per gallon less than current prices. The analysis would indicate that about 2.17% 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 367 million barrels, which up about 4 million barrels on the week.

The graph below is three year history of speculative position levels as of July 1st.

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.