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Petroleum Market Commentary - October 29, 2012

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Lower Prices - Lower Speculation - Inventories Higher

DIESEL:

During the week ending October 26th, the spot month heating oil futures price decreased by 3.67 cents per gallon (-1.17%) while the deferred months decreased by 1 to 4 cents per gallon making the forward pricing curve lower and generally less negatively sloped. The one year forward price ended the week at a 13.92 cent (4.49%) discount to the spot price, from a discount of 14.75 cents (4.71%) 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. Demand includes speculative demand which decreased on the week and can be volatile.

GASOLINE:

During the week ending October 26th, the spot month gasoline futures price increased by 0.28 cents per gallon (+0.10%) while the deferred months decreased by 1 to 3 cents per gallon making the forward pricing curve lower and less negatively sloped except for the spot month. The one year forward price ended the week at a 20.48 cent (8.21%) discount to the spot price, from a discount of 18.04 cents (7.17%) 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:

While not much in the news lately, geopolitical risk continues to support price and the level of speculation. Larger than expected inventories on the week were negative for price. The US Dollar was stronger and the stock market was weaker both of which were negative for petroleum prices. Speculation was down sharply on the week which is negative for price.

Weekly US petroleum demand decreased by 1.96% during the week ending October 19th. Demand is up 1.39% vs. one year ago but remains below the five year average.

Due to price action on the week, short-term hedging became more attractive while longer term hedging became somewhat more attractive in light of the historical range of prices and negatively sloped forward pricing curve allowing hedging further into the future at lower prices. Spot diesel prices are at the 75th percentile 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 less competition with speculators for long futures positions but still at relatively high prices. Spot heating oil futures in the $2.80 - $2.90 level will trigger adding to the hedge position.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of October 26th.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for gasoline fuel, as of October 26th.

Factors affecting the market on the period were:

During the week ended October 19th, total petroleum inventories increased by 6.69 million barrels vs. a five year average decrease of 0.53 million barrels and vs. an expected increase of 0.80 million barrels. Inventories increased by 7.22 million barrels vs. the five year average. Total inventories stand at 691.7 million barrels, up from 685.0 million barrels at the end of the previous week. The five year average inventory is 686.2 million barrels, down from 686.7 at the end of the previous week. Current inventories are 0.81% larger than the five year average up from -0.24% at the end of the previous week. Versus the five year average, inventories turned positive for the first time in a month.



As of October 23rd, the net speculative long position in petroleum futures was 246,489,000 barrels down 41,435,000 barrels (-14.39%) from the previous week. The level of speculation decreased on the week and represents 35.63% of domestic inventories. Speculation is 12.69% below its one year moving average and is 39.69% below the 52 week high level. Levels are now in the lower half of the range that we have seen over the past two years and lower than the one year average. The corresponding spot month heating oil futures price on October 23rd was 304.34 cents per gallon, down 15.51 cents from 319.85 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 88.22% correlated over the past 52 weeks ( lower on the week) indicating that, on a statistical basis over the past year, 77.83% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has weakened in the past several weeks yet remains high. 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 231.30 cents per gallon or 73.04 cents per gallon less than current prices. The analysis would indicate that about 24.00% 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 up again 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 282 million barrels, a decrease of 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.