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Petroleum Market Commentary - December 23, 2013

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Prices Higher - Inventories Lower - Speculation Lower

DIESEL:

During the week ending December 20th, the spot month diesel futures price increased by 10.24 cents per gallon (+3.44%) while the deferred months were up by 1 to 9 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 10.65 cent (3.46%) discount to the spot price, from a discount 4.97 cents (1.67%) and the end of the previous week.

The change in level and slope of this forward pricing curve indicates higher demand expectations and lower supplies with respect to demand. Demand includes speculative demand. 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 December 20th, the spot month gasoline futures price increased by 15.38 cents per gallon (+5.85%) while the deferred months increased by 5 to 14 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 17.56 cent (6.73%) discount to the spot price, from a discount of 7.77 cents (3.05%) 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.

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 continues to be strong but was slightly lower on the week which is marginally supportive of price.


Weekly US petroleum demand increased by 13.16% during the week ending December 13th. Demand is up 4.04% vs. one year ago and demand is currently 0.30% below the five year average. This is the first time since October 18th that demand has been less than the five year average

The attractiveness of making new hedges decreased on the week as prices were higher. Speculation was lower on the week making new hedges involve less competition with speculators for new long positions which is advantageous notwithstanding higher prices. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging will become more attractive.

Below is a one year chart of spot diesel futures prices as of December 20th.

Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of December 20th.

Factors affecting the market on the period were:

During the week ended December 13th, total petroleum inventories decreased by 3.71 million barrels vs. a five year average decrease of 4.14 million barrels and vs. an expected decrease of 3.60 million barrels. Inventories increased by 0.42 million barrels vs. the five year average. Total inventories stand at 708.7 million barrels, down from 712.5 million barrels at the end of the previous week. The five year average inventory is 694.3 million barrels, down from 698.5 million barrels at the end of the previous week.

Current inventories are 2.08% larger than the five year average up from +2.00% at the end of the previous week. Inventories versus the five year average on a percentage basis remain positive. This helps to mitigate the effects of supply disruption and decreases price volatility.

As of December 17th, the net speculative long position in petroleum futures was 314,465,000 barrels down 9,030,000 barrels (-2.79%) from the previous week. Speculation decreased for the first time in five weeks and represents 44.37% of domestic inventories. Speculation is 4.41% above its one year moving average and is 26.68% below the 52-week high set on July 23rd. The corresponding spot month heating oil futures price on December 17th was 296.29 cents per gallon, down 5.44 cents from 301.73 cents per gallon during the previous week.

Diesel fuel price and size of speculative net long position in petroleum are 70.36% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 49.50% of the price movement of diesel fuel is explained by changes in levels of speculation. This statistical relationship continues to strengthened in an environment of relatively high speculation which tends to increase correlation. Other fundamental factors such as higher domestic production remain as important price drivers in the current environment. 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 264.20 cents per gallon or 32.09 cents per gallon less than current prices. The analysis would indicate that about 10.83% of current price is attributable to speculation and its underlying market rationale. The "would be" price was down by about 2 cents on the week.

The net speculative long position has been variable over the past year ranging between 181 million and 429 million barrels with an average of about 301 million barrels, which was up about 2 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, advisory, and consulting firm. Linwood creates and manages customized fuel hedging programs for institutional consumers of petroleum, natural gas, and electricity on a nationwide basis.