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Petroleum Market Commentary - July 15, 2013

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Prices Higher - Inventory Lower - Speculation Higher - Domestic Demand Increasing

DIESEL:

During the week ending July 12th, the spot month diesel futures price increased by 3.97 cents per gallon (+1.33%) while the deferred months increased by 0 to 3 cents per gallon making the forward pricing curve slightly higher and generally more negatively sloped. The one year forward price ended the week at a 9.12 cent (3.01%) discount to the spot price, from a discount of 8.25 cents (2.76%) and the end of the previous week.

The change in level and slope of this forward pricing curve indicates higher demand expectations and lower supplies with respect to demand. Demand includes speculative demand which increased 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 July 12th, the spot month gasoline futures price increased by 22.07 cents per gallon (+7.62%) while the deferred months varied between 0 and +17 cents from the previous week's close. This made the forward pricing curve higher and much more negatively sloped. The one year forward price ended the week at a 36.02 cent (13.06%) discount to the spot price, from a discount of 15.35 cents (5.60%) 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 was lower on the week which is positive for price. Inventories on the week were lower and remain above historical averages. This is positive for price. The stock market, as a proxy for demand expectations, was higher which is positive for price. Speculation was higher on the week which is positive for 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 decreased by 5.65% during the week ending July 5th. Demand is up by 1.60% vs. one year ago and demand is currently 0.89% above the five year average. This is the first time in several years that demand has exceeded the five year moving average mostly because demand has been so depressed in the past five years.

The attractiveness of making new hedges was lower on the week given the higher price environment and higher speculation. Speculation was higher on the week indicating that new hedges would require more 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.

Below is a one year chart of spot diesel futures prices as of July 12th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of July 12th.

Factors affecting the market on the period were:

During the week ended July 5th, total petroleum inventories decreased by 9.47 million barrels vs. a five year average decrease of 0.86 million barrels and vs. an expected decrease of 1.20 million barrels. Inventories decreased by 8.61 million barrels vs. the five year average. Total inventories stand at 718.8 million barrels, down from 728.2 million barrels at the end of the previous week. The five year average inventory is 700.5 million barrels, down from 701.3 million barrels at the end of the previous week.

Current inventories are 2.61% larger than the five year average down from +3.84% 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 July 9th, the net speculative long position in petroleum futures was 312,552,000 barrels, up 37,936,000 barrels (+13.81%) from the previous week. The level of speculation increased for the second week and represents 43.49% of domestic inventories. Speculation is 21.17% above its one year moving average and is 13.14% below the 52 week high level. Speculative levels have risen to near their all-time high levels and to the high levels of the past year's range. The corresponding spot month heating oil futures price on July 9th was 298.57 cents per gallon, up 8.43 cents from 290.14 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 66.56% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 44.31% 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 254.65 cents per gallon or 43.91 cents per gallon less than current prices. The analysis would indicate that about 14.70% of current price is attributable to speculation and its underlying market rationale. The "would be" price was up about 8.0 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 258 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.