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Petroleum Market Commentary - November 4, 2013

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Prices Lower - Inventory Lower - Speculation Lower - Demand Higher

DIESEL:

During the week ending November 1st, the spot month diesel futures price decreased by 2.67 cents per gallon (-3.49%) while the deferred months were unchanged to down 3 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 3.49 cent (1.21%) discount to the spot price, from a discount of 3.98 cents (1.37%) and the end of the previous week.

The change in level and slope of this forward pricing curve indicates lower demand expectations and higher supplies with respect to demand. Demand includes speculative demand. 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 November 1st, the spot month gasoline futures price decreased by 2.20 cents per gallon (-0.86%) while the deferred months changed between up 1 cents to down 2 cents per gallon. This made the forward pricing curve virtually unchanged in level but less negatively sloped. The one year forward price ended the week at a 6.36 cent (2.56%) discount to the spot price, from a discount of 9.62 cents (3.86%) and the end of the previous week.

The change in level and shape of this forward pricing curve indicates lower demand expectations in the near-term 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 lower which is positive for price. The stock market, as a proxy for demand expectations, was higher which is positive for price. Speculation was lower on the week which is negative for price. US domestic crude production continues to be strong but decreased slightly from the 24-year high set a week earlier. This is slightly positive for price.


Weekly US petroleum demand increased by 10.22% during the week ending October 25th. Demand is up 0.98% vs. one year ago and demand is currently 1.56% above the five year average.

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

Below is a one year chart of spot diesel futures prices as of November 1st.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of November 1st.

Factors affecting the market on the period were:

During the week ended October 25th, total petroleum inventories decreased by 0.68 million barrels vs. a five year average decrease of 1.84 million barrels and vs. an expected increase of 3.80 million barrels. Inventories increased by 1.15 million barrels vs. the five year average. Total inventories stand at 720.4 million barrels, down from 721.1 million barrels at the end of the previous week. The five year average inventory is 693.7 million barrels, down from 695.5 million barrels at the end of the previous week.

Current inventories are 3.85% larger than the five year average up from +3.67% at the end of the previous week. Inventories versus the five year average on a percentage basis remain positive. This helps to mitigate the effects of supply disruption and decreases price volatility. This is the highest inventory relative to the five year average since June 28th.

As of October 29th, the net speculative long position in petroleum futures was 278,637,000 barrels down 17,087,000 barrels (-5.78%) from the previous week. The level of speculation is near its 4-month low level of 274 million barrels. This level of speculation represents 38.68% of domestic inventories. Speculation is 4.10% below its one year moving average and is 35.03% below the 52-week high set on July 23rd. The corresponding spot month heating oil futures price on October 29th was 296.41 cents per gallon, down 3.32 cents from 299.73 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 60.96% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 37.16% of the price movement of diesel fuel is explained by changes in levels of speculation. This statistical relationship has strengthened in recent weeks in an environment of relatively high speculation which tends to increase correlation. Other fundamental factors such as higher domestic production remain as important price drivers in the current environment. 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 274.73 cents per gallon or 21.68 cents per gallon less than current prices. The analysis would indicate that about 7.31% of current price is attributable to speculation and its underlying market rationale. The "would be" price was down by about 1.5 cents on the week.

The net speculative long position has been variable over the past year ranging between 181 million and 429 million barrels with an average of about 291 million barrels, which was an increase of about 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.