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Petroleum Market Commentary - September 2, 2013

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Curves Steady & More Negative - Inventory Higher - Speculation Higher

DIESEL:

During the week ending August 30th, the spot month diesel futures price increased by 4.45 cents per gallon (+1.44%) while the deferred months changed between up 4 and down 6 cents per gallon making the forward pricing curve steady and more negatively sloped. The one year forward price ended the week at a 17.15 cent (5.46%) discount to the spot price, from a discount of 12.13 cents (3.92%) and the end of the previous week.

The change in level and slope of this forward pricing curve indicates steady demand expectations and lower supplies with respect to demand. Demand includes speculative demand which increased slightly from record highs 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 August 30th, the spot month gasoline futures price increased by 1.14 cents per gallon (+0.38%) while the deferred months changed between up 3 cents and down 2 cents per gallon. This made the forward pricing curve steady and more negatively sloped. The one year forward price ended the week at a 24.24 cent (8.73%) discount to the spot price, from a discount of 23.19 cents (8.36%) 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 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 continues to be strong and increased on the week to a new 23-year high which is negative for price. Geopolitical risk, especially in Syria continues to be a background factor that is supportive of price through speculation.


Weekly US petroleum demand increased by 0.58% during the week ending August 23rd. Demand is down 0.06% vs. one year ago and demand is currently 0.83% below the five year average.

The attractiveness of making new longer-term hedges increased on the week with forward prices lower despite higher speculation and higher spot prices. 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 August 30th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of August 30th.

Factors affecting the market on the period were:

During the week ended August 23rd, total petroleum inventories increased by 2.08 million barrels vs. a five year average increase of 1.00 million barrels and vs. an expected decrease of 1.50 million barrels. Inventories increased by 1.08 million barrels vs. the five year average. Total inventories stand at 708.9 million barrels, up from 706.8 million barrels at the end of the previous week. The five year average inventory is 704.3 million barrels, up from 703.3 million barrels at the end of the previous week.

Current inventories are 0.66% larger than the five year average up from +0.51% 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 August 27th, the net speculative long position in petroleum futures was 415,631,000 barrels up 17,922,000 barrels (+4.51%) from the previous week. The level of speculation increased for the second week in a row. This level of speculation represents 58.63% of domestic inventories. Speculation is 47.59% above its one year moving average and is 3.10% below the 52-week high. The corresponding spot month heating oil futures price on August 27th was 316.09 cents per gallon, up 8.25 cents from 307.84 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 50.24% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 25.24% of the price movement of diesel fuel is explained by changes in levels of speculation. This statistical relationship has stabilized in recent weeks but remains relatively low 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 277.57 cents per gallon or 38.52 cents per gallon less than current prices. The analysis would indicate that about 12.19% of current price is attributable to speculation and its underlying market rationale. The "would be" price was down about 1 cent 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 282 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.