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Petroleum Market Commentary - December 19, 2011

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Stronger Dollar - European Worries - OPEC Pumping More

During the week ending December 16th, the spot month heating oil futures price decreased by 11.20 cents per gallon (-3.85%) while the deferred months decreased by 13 to 15 cents per gallon making the forward pricing curve lower and flatter (less positively sloped). The one year forward price ended the week at a 2.09 cent (0.75%) premium to the spot price, from a premium of 5.89 cents (2.02%) at the end of the previous week.

The change in level and shape of the forward pricing indicates a decrease in demand expectations (which includes investment demand) and a decrease in inventories with respect to demand expectations as inventories. The positive slope of the forward pricing curve indicates slack inventories with respect to demand and demand expectations. A positively sloped forward pricing curve is usually accompanied by general price weakness. A nearly flat curve indicates a balance in supply, demand, expected supply and expected demand.

The US Dollar increased significantly on the week exerting downward pressure on petroleum prices, the stock market decreased exerting downward pressure on prices while continued weaker petroleum demand kept downward pressure on prices. Overall petroleum inventories increased more than expected which weakened prices.

Speculation decreased slightly on the week and remains relatively high which is supportive of price. Price and speculative levels continue to have a weak statistical relationship suggesting that the linkage is stronger when the level of speculation is extreme.

Weekly US petroleum demand increased by 0.55% on a week over week basis for the week ending December 9th. The four week moving average of domestic demand is at its lowest level since May 2009.

Prices are in the middle of the range that they have been in over the last twelve months and near the lower portion 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 in a more significant degree in order to establish cost certainty in forward periods at relatively attractive prices. 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 16th.

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 9th, total petroleum inventories increased by 2.37 million barrels vs. a five year average decrease of 1.76 million barrels and vs. an expected decrease of 0.50 million barrels. Inventories increased by 4.13 million barrels vs. the five year average. Total inventories stand at 694.5 million barrels up from 692.1 million barrels at the end of the previous week. The five year average inventory is 679.1 million barrels, down from 680.9 at the end of the previous week. Current inventories are 2.26% larger than the five year average up from +1.65% at the end of the previous week.

As of December 13th, the net speculative long position in petroleum futures was 288,079,000 barrels down 4,723,000 barrels (-1.61%) from the previous week. This position represents 41.48% of domestic inventories. Speculation levels decreased on the week mostly due to the significantly stronger dollar which was a result of the European situation that deteriorated on the week. Speculation is 2.96% below its one year moving average and is 25.33% lower than the 52 week high and roughly at the high levels in 2010. The corresponding spot month heating oil futures price on December 13th was 292.88 cents per gallon, down 9.29 cents from 302.17 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 31.15% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 9.71% 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 263.96 cents per gallon or 28.92 cents per gallon less than current prices. The analysis would indicate that about 9.87% 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 297 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.