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Petroleum Market Commentary - November 5, 2012

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Two Month Low Prices - Lower Speculation - Hurricane

DIESEL:

During the week ending November 2nd, the spot month heating oil futures price decreased by 12.90 cents per gallon (-4.19%) while the deferred months decreased by 4 to 11 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 4.05 cent (1.37%) discount to the spot price, from a discount of 13.92 cents (4.49%) 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 November 2nd, the spot month gasoline futures price decreased by 6.81 cents per gallon (-2.58%) while the deferred months decreased by 6 to 8 cents per gallon making the forward pricing curve lower and relatively unchanged in slope and shape. The one year forward price ended the week at a 15.28 cent (6.31%) discount to the spot price, from a discount of 20.48 cents (8.21%) and the end of the previous week.

The change in level and shape of this forward pricing curve indicates lower demand expectations and steady inventory levels with respect to supply and demand.

ANALYSIS:

Geopolitical risk continues to support price and the level of speculation while the Iranian and Syrian situations have not posed any additional threat to supply in the past weeks. Smaller than expected inventories on the week were supportive of price. The US Dollar was stronger and the stock market was slightly weaker both of which were negative for petroleum prices. Speculation was down again on the week which is negative for price.

Weekly US petroleum demand decreased by 4.23% during the week ending October 26th. Demand is up 1.49% vs. one year ago but remains below the five year average.

Due to price action on the week, short-term hedging became attractive while longer term hedging became 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 near the middle of the 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 and at relatively attractive prices. Spot heating oil futures in the $2.80 - $2.90 level will trigger additional hedging.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of November 2nd.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for gasoline fuel, as of November 2nd.

Factors affecting the market on the period were:

During the week ended October 26th, total petroleum inventories decreased by 1.20 million barrels vs. a five year average decrease of 1.96 million barrels and vs. an expected decrease of 0.15 million barrels. Inventories increased by 0.75 million barrels vs. the five year average. Total inventories stand at 690.5 million barrels, down from 691.7 million barrels at the end of the previous week. The five year average inventory is 684.2 million barrels, down from 686.2 at the end of the previous week. Current inventories are 0.92% larger than the five year average up from +0.81% at the end of the previous week. Versus the five year average, inventories remained positive for the second week.



As of October 30th, the net speculative long position in petroleum futures was 224,620,000 barrels down 21,869,000 barrels (-8.87%) from the previous week. The level of speculation decreased on the week and represents 32.53% of domestic inventories. Speculation is 20.09% below its one year moving average and is 45.04% 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 30th was 308.66 cents per gallon, up 4.32 cents from 304.34 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 86.82% correlated over the past 52 weeks ( lower on the week) indicating that, on a statistical basis over the past year, 75.38% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship continues to weaken 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 233.30 cents per gallon or 75.36 cents per gallon less than current prices. The analysis would indicate that about 24.42% of current price is attributable to speculation and its underlying market rationale. The "would be" price has bottomed, is slowly rising, and was up again by two cents 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 281 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.