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Petroleum Market Commentary - September 24, 2012

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Prices Lower - Speculation Up

During the week ending September 21st, the spot month heating oil futures price decreased by 11.88 cents per gallon (-3.67%) while the deferred months decreased by 9 to 15 cents per gallon making the forward pricing curve lower and more negatively sloped over the next two years. The one year forward price ended the week at a 14.46 cent (4.63%) discount to the spot price, from a discount of 13.53 cents (4.18%) and the end of the previous week.

The change in level and shape of the forward pricing curve indicates lower demand expectations and relatively stable inventory levels with respect to supply and demand. Demand includes speculative demand which increased again 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 18th. The statistical relationship between price and speculative levels remains high.

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

Weekly US petroleum demand increased by 1.86% during the week ending September 14th. Demand is down 2.92% vs. one year ago.

Prices were lower during the period. Short-term hedging became relatively more attractive while longer term hedging is somewhat attractive in light of the historical range of prices. Spot prices remain in the top quartile 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 21st.

Factors affecting the market on the period were:

During the week ended September 14th, total petroleum inventories increased by 6.81 million barrels vs. a five year average decrease of 0.63 million barrels and vs. an expected increase of 3.00 million barrels. Inventories increased by 7.43 million barrels vs. the five year average. Total inventories stand at 692.2 million barrels, up from 685.4 million barrels at the end of the previous week. The five year average inventory is 688.1 million barrels, down from 688.7 at the end of the previous week. Current inventories are 0.59% larger than the five year average up from -0.49% at the end of the previous week. Versus the five year average, inventories turned positive for the first time in 8 weeks. While this is somewhat negative for price, lower inventories due to lower demand continue to be negative for price.



As of September 18th, the net speculative long position in petroleum futures was 318,540,000 barrels up 15,059,000 barrels (+4.96%) from the previous week. The level of speculation increased on the week and remains at the levels seen in early May. This position represents 46.02% of domestic inventories. Speculation is 14.45% above its one year moving average and is 22.07% 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 18th was 312.71 cents per gallon, down 5.86 cents from 318.57 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 91.35% correlated over the past 52 weeks (slightly higher on the week) indicating that, on a statistical basis, 83.45% 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 230.11 cents per gallon or 82.60 cents per gallon less than current prices. The analysis would indicate that about 26.41% of current price is attributable to speculation and its underlying market rationale. The "would be" price has stabilized at the $2.30 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 278 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.