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Petroleum Market Commentary - October 27, 2014

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Prices Steadying - Dollar Up - Speculation Bottoming - Saudi Uncertainty

DIESEL:

During the week ending October 24th, the spot month diesel futures price decreased by 1.57 cents per gallon (-0.63%) while the deferred months were lower by 0-2 cents per gallon making the forward pricing curve lower and generally unchanged in slope. The one year forward price ended the week at a 3.21 cent premium to the spot price, from a premium of 2.84 cents at the end of the previous week.

The change in level and slope of the diesel forward pricing curve indicates lower demand expectations and steady supplies with respect to demand. Demand includes speculative demand which was higher on the week. 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 October 24th, the spot month gasoline futures price decreased by 5.10 cents per gallon (-2.28%) while the deferred months decreased by 0 to 2 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 1.09 cent discount to the spot price, from a discount of 5.43 cents 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 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 sharply higher which is positive for price. Speculation was higher on the week which is positive for price. US domestic crude production was lower on the week which is positive for price. Domestic production is up 13.15% year over year.

Prices have decreased significantly in the past several weeks due to:

Mitigating factors to further downward price movements include:

The big question is what will happen at the regularly scheduled OPEC meeting on November 27th. Will OPEC and Saudi Arabia in particular curtail production in order to support price or will they leave production unchanged thus enforcing a new lower price range, protecting their market share, and discouraging the pace of oil supply growth.

DEMAND:

Weekly US petroleum demand decreased by 4.85% during the week ending October 17th. Domestic demand is up 2.23% vs. one-year ago and demand is currently 3.26% over the five year average.

The attractiveness of making new hedges was steady on the week as prices were lower and speculation was higher. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging may become more attractive.

PRODUCTION:

Domestic production was lower on the week following a new high in the previous week. Domestic production has grown by 3 million barrels per day in the past three years. This represents more than 3% of global daily consumption and roughly 15% of domestic consumption. This growth is a major factor in the shift in price and fundamental market factors for global petroleum markets. It is beginning to affect the global balance of political power. This production is expensive however and further growth would be dampened by relatively low prices.



Below is the one-year chart of spot diesel futures prices as of October 24th.



Below is the one-year chart of spot gasoline futures prices as of October 24th.

MARKET FACTORS:

: :  Inventories increasing by 6.86 million barrels while inventories were expected to decrease by 0.70 million barrels on the week. The five-year-average inventory increased by 2.01 million barrels. Inventories increased vs. the five year average and vs. expectations.

: :  OPEC is not expected to take any action to curtail supply until their meeting on November 27th. Then there is speculation that Saudi Arabia may not cut its output but rather push prices down to maintain its market share.

: :  China showing signs of economic strength with their third quarter GDP being stronger than expected and Chinese crude oil processing up 9.1% year over year to the highest level in 15 months. The October Chinese HSBC manufacturing purchasing managers' index increased unexpectedly. While these things don't indicate a Chinese economy that is growing rapidly but does indicate that it is perhaps not as weak as first thought.

: :  Stronger than expected US September existing home sales and stronger than expected domestic leading indicators indicate relative strength in the US economy. This is positive for economic growth prospects, petroleum demand expectations, and price.

: :  Eurozone October manufacturing activity ticked up unexpectedly showing some strength in the European economy which is a bright spot in a story that shows Europe in sluggish growth or a mild recession. The slow economy in Europe is negative for petroleum demand growth but good news is positive for demand growth and price at the margin.

: :  Stock market increasing sharply by 4.18% on the week which is positive for economic and petroleum demand expectations and prices.

: :  The US Dollar increasing by 0.71% on the week which is negative for petroleum price. Commodities are used as a hedge against inflation and against a falling dollar. A stronger dollar reduces the relative demand for commodities for this purpose and prices decrease accordingly. Conversely, a weaker dollar increases relative demand for commodities and prices increase.

INVENTORIES:

During the week ended October 17th, total petroleum inventories increased by 6.86 million barrels vs. a five year average increase of 2.01 million barrels and vs. an expected decrease of 0.70 million barrels. Inventories increased by 4.85 million barrels vs. the five year average. Total inventories stand at 707.7 million barrels, up from 700.9 million barrels at the end of the previous week. The five year average inventory is 713.3 million barrels, up from 711.3 million barrels at the end of the previous week.

Current inventories are 0.78% lower than the five year average, up from -1.47% at the end of the previous week. Inventory levels continue to remain close to the five year average.



SPECULATION:

As of October 21st, the net speculative long position in petroleum futures was 186,082,000 barrels up 19,912,000 barrels (+11.98%) from the previous week. Speculation increased for the first time in three weeks and represents 26.29% of domestic inventories. Speculation is 42.59% below its one year moving average. The corresponding spot month diesel futures price on October 21st was 251.32 cents per gallon, up 4.10 cents from 247.22 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 67.30% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 45.29% of the price movement of diesel fuel is explained by changes in levels of speculation. 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 257.87 cents per gallon or 6.55 cents per gallon more than current prices. The analysis would indicate that about -2.61% of current price is attributable to speculation and its underlying market rationale.

The net speculative long position has been variable over the past year ranging between 166 million and 453 million barrels with an average of about 324 million barrels, which is down about 3 million barrels on the week.

CONTACT:

Linwood Capital, LLC is an institutional fuel hedging management, advisory, and consulting firm. Linwood creates and manages customized fuel hedging programs for institutional consumers of petroleum and natural gas.