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Petroleum Market Commentary - December 12, 2011

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Markets Work - Larger Inventories - Slack Demand - Lower Prices

During the week ending December 9th, the spot month heating oil futures price decreased by 7.75 cents per gallon (-2.95%) while the deferred months decreased by 2 to 6 cents per gallon making the forward pricing curve lower and positively sloped. The one year forward price ended the week at a 5.89 cent (2.02%) premium to the spot price, from a premium of 0.42 cents (0.14%) 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 increase in inventories with respect to demand expectations as inventories grew much more than expected for the second week in a row. The positive slope of the forward pricing curve indicates large inventories with respect to demand and demand expectations. A positively sloped forward pricing curve is usually accompanied by general price weakness.

The US Dollar decreased slightly on the week exerting slight upward pressure on petroleum prices, the stock market increased exerting upward pressure on prices while continued weaker petroleum demand kept downward pressure on prices. Overall petroleum inventories increased much more than expected which weakened prices. It is interesting to note that the stock market and the petroleum markets continue to go in opposite directions.

Speculation increased slightly on the week and remains relatively high which is supportive of price. Price and speculative levels continue to become statistically less linked suggesting that the linkage is stronger when the level of speculation is extreme.

Weekly US petroleum demand increased by 2.02% on a week over week basis for the week ending December 2nd. The four week moving average of domestic demand is at its lowest level since May. Markets work and eventually bring more supply and curtail demand and stabilize or lower prices.

Prices are in the upper half of the range that they have been in over the last twelve months and near the middle of the range that we have seen in the past six months which increases the relative attractiveness of adding to short and medium term hedge positions. Longer-term positions can be entered into but only in smaller percentages 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 December 9th.

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 December 2nd, total petroleum inventories increased by 9.02 million barrels vs. a five year average decrease of 1.31 million barrels and vs. an expected increase of 0.775 million barrels. Inventories increased by 10.33 million barrels vs. the five year average. Total inventories stand at 692.1 million barrels up from 683.1 million barrels at the end of the previous week. The five year average inventory is 680.9 million barrels, down from 682.2 at the end of the previous week. Current inventories are 1.65% larger than the five year average up from +0.13% at the end of the previous week.

As of December 6th, the net speculative long position in petroleum futures was 292,802,000 barrels up 11,061,000 barrels (+3.93%) from the previous week. This position represents 42.31% of domestic inventories. Speculation levels increased for the first time in three weeks. The stock market increasing and the dollar not increasing gave support to demand expectations which supported speculative activity as did concerns over Iran. Speculation is 1.50% below its one year moving average and is 27.21% lower than the 52 week high and roughly at the high levels in 2010. The corresponding spot month heating oil futures price on December 6th was 302.17 cents per gallon, up 0.06 cents from 302.11 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 28.35% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 8.03% 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 264.11 cents per gallon or 38.06 cents per gallon less than current prices. The analysis would indicate that about 12.6% of current price is attributable to speculation and its underlying market rationale. The "would be" price has come up by over $1 per gallon over the past seven months and the percent of price attributable to speculation has decreased. The "would be" price did not increase on the week as it has been doing rather consistently throughout 2011. 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 298 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.