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Petroleum Market Commentary - September 17, 2012

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Prices Higher - QE3 - Steeper Curve - Speculation Up

During the week ending September 14th, the spot month heating oil futures price increased by 9.06 cents per gallon (+2.88%) while the deferred months increased by 2 to 8 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 13.53 cent (4.18%) discount to the spot price, from a discount of 8.55 cents (2.72%) and the end of the previous week.

The change in level and shape of the forward pricing curve indicates higher demand expectations and relatively less plentiful inventory levels with respect to supply and demand. Demand includes speculative demand which increased on the week and can be volatile. Continuing supply disruption fears caused by the Iranian situation and relatively tight inventories with respect to the historical averages have caused the front end of the curve to increase relative to the far end and for the curve to be negatively sloped. Speculation increased on the week ended September 11th. The statistical relationship between price and speculative levels remains high.

The US Dollar was lower again on the week which is positive for petroleum prices. The US stock market was higher again on the week which is positive for petroleum prices. Petroleum demand for the week was lower which kept downward pressure on prices. Overall petroleum inventories increased vs. expectations and vs. the five-year average keeping downward pressure on prices.

Weekly US petroleum demand decreased by 4.98% during the week ending September 7th. Demand is down 2.66% vs. one year ago.

Prices were higher during the period. Short-term hedging remains less attractive while longer term hedging remains relatively attractive in light of the historical range of prices. Spot prices are near the upper decile of the 80 cent price range that we have seen over the past twelve months. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging will become more attractive. Entering new, longer-term hedges at these levels would involve more competition with speculators for long futures positions as speculative levels have risen which is a disadvantage to the hedger.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of September 14th.

Factors affecting the market on the period were:

During the week ended September 7th, total petroleum inventories increased by 2.29 million barrels vs. a five year average decrease of 5.59 million barrels and vs. an expected decrease of 5.40 million barrels. Inventories increased by 7.88 million barrels vs. the five year average. Total inventories stand at 685.4 million barrels, up from 683.1 million barrels at the end of the previous week. The five year average inventory is 688.7 million barrels, down from 694.3 at the end of the previous week. Current inventories are 0.49% smaller than the five year average up from -1.62% at the end of the previous week. Versus the five year average, inventories remain negative. While this is supportive of price, lower inventories are also due to lower demand which is negative for price.



As of September 11th, the net speculative long position in petroleum futures was 303,481,000 barrels up 10,528,000 barrels (+3.59%) from the previous week. The level of speculation increased on the week and remains at the levels seen in early May. This position represents 44.28% of domestic inventories. Speculation is 9.65% above its one year moving average and is 25.75% below the 52 week high level. Levels remain near the middle of the range that we have seen over the past two years. The corresponding spot month heating oil futures price on September 11th was 318.57 cents per gallon, up 3.89 cents from 314.68 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 91.17% correlated over the past 52 weeks (slightly lower on the week) indicating that, on a statistical basis, 83.12% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has strengthened in the past several months, and has become stronger as prices have been relatively more volatile. 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 230.60 cents per gallon or 87.98 cents per gallon less than current prices. The analysis would indicate that about 27.62% of current price is attributable to speculation and its underlying market rationale. The "would be" price has stabilized at the $2.31 level over the past several weeks and was down slightly on the week.

The net speculative long position has been variable over the past year ranging between 70 million and 410 million barrels with an average of about 277 million barrels, an increased by roughly 1 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.