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Petroleum Market Commentary - November 21, 2011

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Lower Prices - Flatter Curve - European Worries

During the week ending November 18th, the spot month heating oil futures price decreased by 13.91 cents per gallon (-4.39%) while the deferred months decreased by 7 to 11 cents per gallon making the forward pricing curve lower and generally less negatively sloped. The one year forward price ended the week at a 5.16 cent (1.70%) discount to the spot price, down from a discount of 11.40 cents (3.59%) at the end of the previous week.

The change in level and shape of the forward pricing indicates a decrease in demand expectations and an easing in supply tightness where inventories are more plentiful with respect to demand expectations. A negatively sloped forward pricing curve indicates relative tightness in supply with respect to demand and inventories. This is usually accompanied by general price support. We saw this effect ease somewhat on the week.

The US Dollar increased on the week exerting downward pressure on petroleum prices, the stock market decreased exerting downward pressure on prices while weaker petroleum demand and the smaller than expected decrease in inventories kept downward pressure on prices.

Speculation increased on the week to its highest level in 6 months. The speculative demand kept upward pressure on prices despite a stronger dollar and weaker stock market. Speculative activity is supportive of price. As the level of speculation decreases, price and speculative levels continue to become less linked suggesting that the linkage is stronger when speculation levels are extreme.

Weekly US petroleum demand decreased by 3.62% on a week over week basis for the week ending November 11th.

Prices have come nearer to the middle of the range that they have been in over the last nine months which increases the relative attractiveness of adding to short and medium term hedge positions. Longer-term positions can be entered into incrementally and in slightly larger amounts in order to establish some degree of cost certainty in forward periods. Hedging in the short-term at these prices is to capture opportunity in so far as opportunity has not been addressed previously and for the management of budget risk as needed. As prices move and as time passes, the advisability of medium to longer-term hedging will change.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of November 18th.

Factors affecting the market on the week

Macro factors:

US economic data and news including:

Global economic data and news including:

During the week ended November 11th, total petroleum inventories decreased by 2.20 million barrels vs. a five year average decrease of 3.20 million barrels and vs. an expected decrease of 4.55 million barrels. Inventories increased by 1.00 million barrels vs. the five year average. Total inventories stand at 675.9 million barrels down from 678.1 million barrels at the end of the previous week. The five year average inventory is 678.0 million barrels, down from 681.2 at the end of the previous week. Current inventories are 0.31% smaller than the five year average up from -0.45% at the end of the previous week.

As of November 15th, the net speculative long position in petroleum futures was 318,578,000 barrels up 13,186,000 barrels (+4.32%) from the previous week. This position represents 47.13% of domestic inventories. Speculation levels increased for the second week in a row indicating a further increase in the investment appetite for petroleum. Speculation is 7.56% above its one year moving average and is 22% lower than the peaks we saw earlier this year and roughly at the levels we saw in early 2010. The corresponding spot month heating oil futures price on November 15th was 317.13 cents per gallon, up 5.52 cents from 311.61 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 31.67 correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 10.03% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has continued to be weak over the past few months and, considering the past year's data, has become somewhat irrelevant but is worth monitoring as an indicator of how the hedger is competing with the speculator for forward pricing. It has, however, stopped declining and has increased slightly in the past several weeks. 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 250.52 cents per gallon or 66.61 cents per gallon less than current prices. The analysis would indicate that about 21% of current price is attributable to speculation and its underlying market rationale. The "would be" price has come up about $1 per gallon over the past six months and the percent of price attributable to speculation has decreased. This would suggest that speculation was ahead of market fundamentals that have now been realized.

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 296 million barrels.

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.