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Petroleum Market Commentary - July 29, 2013

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Prices Lower - Inventory Lower - Speculation to Record High

DIESEL:

During the week ending July 26th, the spot month diesel futures price decreased by 7.93 cents per gallon (-2.57%) while the deferred months decreased by 1 to 7 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at an 8.62 cent (2.86%) discount to the spot price, from a discount of 12.97 cents (4.20%) and the end of the previous week.

The change in level and slope of this forward pricing curve indicates lower demand expectations and higher 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 July 26th, the spot month gasoline futures price decreased by 7.90 cents per gallon (-2.53%) while the deferred months were lower by 1 to 6 cents per gallon. This made the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 29.35 cent (10.67%) discount to the spot price, from a discount of 35.87 cents (12.97%) 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.

ANALYSIS:

The US dollar was lower on the week which is positive for price. Inventories on the week were steady and remain above historical averages. This is neutral 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 increased by 1.64% during the week ending July 19th. Demand is up 4.06% vs. one year ago and demand is currently 3.03% above the five year average.

The attractiveness of making new hedges was mixed on the week with prices lower but speculation levels higher. Since speculation was higher on the week, making new hedges would involve more competition with speculators for long futures positions. As prices move and as time passes, the advisability of hedging will change. As price opportunities present themselves, hedging will become more attractive.

Below is a one year chart of spot diesel futures prices as of July 26th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of July 26th.

Factors affecting the market on the period were:

During the week ended July 19th, total petroleum inventories decreased by 5.44 million barrels vs. a five year average increase of 6.45 million barrels and vs. an expected increase of 0.10 million barrels. Inventories decreased by 11.89 million barrels vs. the five year average. Total inventories stand at 713.3 million barrels, down from 718.8 million barrels at the end of the previous week. The five year average inventory is 709.9 million barrels, up from 703.4 million barrels at the end of the previous week.

Current inventories are 0.49% larger than the five year average down from +2.18% 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 23rd, the net speculative long position in petroleum futures was 428,910,000 barrels up 61,035,000 barrels (+16.59%) from the previous week. The level of speculation increased for the fourth week in a row to a new all-time high level. Higher than in 2008 when prices peaked. This level of speculation represents 6.012% of domestic inventories. Speculation is 61.34% above its one year moving average and is at a new 52 week high level. The corresponding spot month heating oil futures price on July 23rd was 306.93 cents per gallon, up 2.24 cents from 304.69 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 57.56% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis over the past year 33.13% of the price movement of diesel fuel is explained by changes in levels of speculation. This statistical relationship continues to become weaker as other fundamental factors become more important price drivers. 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 266.95 cents per gallon or 39.98 cents per gallon less than current prices. The analysis would indicate that about 13.02% of current price is attributable to speculation and its underlying market rationale. The "would be" price was up about 7.0 cents on the week.

The net speculative long position has been variable over the past year ranging between 181 million and 429 million barrels with an average of about 266 million barrels, which was an increase of about 4 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.