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Petroleum Market Commentary - October 10, 2011

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Prices Bottom - Speculation Lower Again

During the week ending October 7th, the spot month heating oil futures price increased by 7.95 cents per gallon (+2.86%) while the deferred months increased by 4 to 7 cents per gallon making the forward pricing curve slightly higher more negatively sloped. The one year forward price ended the week at a 12.22 cent (4.27%) discount to the spot price, up from a discount of 11.68 cents (4.18%) at the end of the previous week.

Heating Oil Forward Pricing Curve Chart

The change in level of the forward pricing indicates an increase in demand expectations while the change in the slope of the curve indicates a tightening of inventory with respect to demand expectations. A negatively sloped forward pricing curve indicates relative tightness in supply with respect to demand and inventories.

The US Dollar increased slightly on the week exerting slight downward pressure on petroleum prices, the stock market increased exerting upward pressure on prices while the significant decrease in inventories was vs. the expectations of an increase which was supportive of prices.

Speculation decreased again to a one-year low during the week from 9/27 to 10/4 putting downward pressure on prices. Speculative activity is supportive of price. As the level of speculation decreases, price and speculative levels continue to become less linked suggesting that the linkage is stronger when speculation levels are extreme.

Weekly US petroleum demand increased by 0.09% on a week over week basis for the week ending September 30th.

Prices are now just off the low of the range for the past eight months which increases the attractiveness of adding to short and medium term hedge positions. Longer-term positions can be increased incrementally from relatively low levels at current prices if needed to control longer-term budget risk. As prices move and as time passes, the advisability of medium to longer-term hedging will change.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of October 7th.

Heating Oil Nearest Futures Chart

Factors affecting the market on the week

Macro factors:

US economic data and news including:

Global economic data and news including:

During the week ended September 30th, total petroleum inventories decreased by 6.56 million barrels vs. a five year average increase of 1.88 million barrels and vs. an expected increase of 2.75 million barrels. Inventories decreased by 8.44 million barrels vs. the five year average. Total inventories stand at 706.9 million barrels down from 713.5 million barrels at the end of the previous week. The five year average inventory is 683.5 million barrels, up from 681.7 at the end of the previous week. Current inventories are 3.42% larger than the five year average down from +4.67% at the end of the previous week.

Average Petroleum Inventory Chart

As of October 4th, the net speculative long position in petroleum futures was 192,393,000 barrels down 9,925,000 barrels (-4.91%) from the previous week. This position represents 27.21% of domestic inventories. Speculation levels declined again on the week to a new one-year low indicating a decrease in investment appetite for petroleum mostly due to a stronger dollar and a general "risk off" market attitude during the week. Speculation is 35% below its one year average and is 53% lower than the peaks we saw several months ago and lower than the peaks we saw in early 2010. The corresponding spot month heating oil futures price on October 4th was 272.34 cents per gallon, down 15.32 cents from 287.66 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 32.41% correlated over the past 52 weeks indicating that, on a statistical basis, 10.51% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has continued to weaken over the past few months and, considering the past year's data, has become somewhat irrelevant but is worth monitoring as an indicator of how the hedger is competing with the speculator for forward pricing. 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 229.84 cents per gallon or 42.50 cents per gallon less than current prices. The analysis would indicate that about 16% of current price is attributable to speculation and its underlying market rationale. The "would be" price has come up about 80 cents in the past months and the percent of price attributable to speculation has decreased.

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 297 million barrels.

The graph below is three year history of speculative position levels.

Market Speculation Chart