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Petroleum Market Commentary - November 10, 2014

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Prices Lower - Dollar Up - Speculation Lower - Production Record

DIESEL:

During the week ending November 7th, the spot month diesel futures price decreased by 1.14 cents per gallon (-0.45%) while the deferred months were lower by 0-4 cents per gallon making the forward pricing curve lower and generally more positively sloped. The one year forward price ended the week at a 0.64 cent premium to the spot price, from a premium of 2.30 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 higher supplies with respect to demand. Demand includes speculative demand which was lower 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 November 7th, the spot month gasoline futures price decreased by 1.26 cents per gallon (-0.59%) while the deferred months decreased by 3 to 5 cents per gallon making the forward pricing curve lower and less positively sloped. The one year forward price ended the week at a 0.06 cent discount to the spot price, from a premium of 0.98 cents and the end of the previous week.

The change in level and shape of this forward pricing curve indicates lower demand expectations and lower 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 was higher on the week to a new all-time 40 year high which is negative for price. Domestic production is up 14.18% year over year.

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

Mitigating factors to further downward price movements include:

Will OPEC curtail production at its regularly scheduled 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. During the past week it appears that Saudi Arabia will continue to lower prices to retain market share. The question is how much of this is already baked into the lower price and is the market price already down to its natural cushion price where demand will be stimulated and supply curtailed?

As in 2007 and 2008 when supply could not keep up with demand, global spare capacity of crude production was low and prices increased, now, after several years of high prices and incentive to increase supply, demand is not keeping up with supply and there is an excess of spare oil production in the world. A lower priced environment will allow demand to catch up to supply and for global spare crude production capacity to shrink. This will support prices. Whether prices have further lower to go in this process remains to be seen.

DEMAND:

Weekly US petroleum demand decreased by 2.26% during the week ending October 31st. Domestic demand is up 0.37% vs. one-year ago and demand is currently 1.76% over the five year average.

The attractiveness of making new hedges was higher on the week as price and speculation were both lower. From a flat-price basis, prices are very attractive. There also appears to be support in the market at current prices which mitigates the risk of opportunity cost in new hedging. 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 higher on the week to yet another new 40 year high level. 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 should lower prices persist. The number of drilling rigs employed in North Dakota drilling has decreased in recent weeks.



Below is the one-year chart of spot diesel futures prices as of October 31st.



Below is the one-year chart of spot gasoline futures prices as of October 31st.

MARKET FACTORS:

: :  Inventories decreasing by 1.64 million barrels while inventories were expected to decrease by 0.55 million barrels on the week. The five-year-average inventory decreased by 3.46 million barrels. Inventories increased vs. the five year average and decreased vs. expectations.

: :  OPEC increasing production in October to 30.074 million barrels per day which is a 14-month high level. This sustained high production by OPEC is the main reason that prices have slipped in the past two months. Higher production is negative for price.

: :  Saudi Arabia reduced the price of its crude oil sold to the United States in an attempt to retain market share. Since Saudi Arabia is a low-cost producer, it has the leverage to simply sell at lower prices making domestic production less attractive. Lower prices will retard production growth and allow Saudi Arabia to enjoy a higher volume of sales albeit at a lower price. If they did not lower their price but simply continued to cut production, they would eventually be out of business.

: :  The Euro Commission cut its forecasted GDP growth rates for the Eurozone for 2014 and 2015 indicating a softer than expected economy which is negative for petroleum demand expectations and price.

: :  The October US unemployment rate unexpectedly dropped to a 6 year low level of 5.8%. This is supportive of labor market prospects, domestic economic growth expectations, petroleum demand expectations, and price.

: :  Stock market increasing by 0.69% on the week which is positive for economic and petroleum demand expectations and prices.

: :  The US Dollar increasing by 0.83% to a new four-year high 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 31st, total petroleum inventories decreased by 1.64 million barrels vs. a five year average decrease of 3.46 million barrels and vs. an expected decrease of 0.55 million barrels. Inventories increased by 1.82 million barrels vs. the five year average. Total inventories stand at 701.6 million barrels, down from 703.3 million barrels at the end of the previous week. The five year average inventory is 707.6 million barrels, down from 711.1 million barrels at the end of the previous week.

Current inventories are 0.85% lower than the five year average, up from -1.10% at the end of the previous week. Inventory levels continue to remain close to the five year average.



SPECULATION:

As of November 4th, the net speculative long position in petroleum futures was 167,756,000 barrels down 10,110,000 barrels (-5.69%) from the previous week. Speculation decreased for the second week in a row and represents 23.91% of domestic inventories. Speculation is 47.64% below its one year moving average. The corresponding spot month diesel futures price on November 4th was October 28th was 244.27 cents per gallon, down 5.04 cents from 249.31 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 71.22% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 50.72% 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 250.42 cents per gallon or 6.15 cents per gallon more than current prices. The analysis would indicate that about -2.52% of current price is attributable to speculation and its underlying market rationale. This "would be" price was about 4 cents lower on the week.

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 320 million barrels, which is down about 2 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.