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Petroleum Market Commentary - December 26, 2011

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During the week ending December 23rd, the spot month heating oil futures price increased by 9.02 cents per gallon (+3.22%) while the deferred months increased by 5 to 9 cents per gallon making the forward pricing curve higher and negatively sloped. The one year forward price ended the week at a 1.74 cent (0.60%) discount to the spot price, from a premium of 2.09 cents (0.75%) at the end of the previous week.

The change in level and shape of the forward pricing indicates an increase in demand expectations (which includes investment demand) and a decrease in inventories with respect to demand expectations and inventory expectations in light of any supply disruptions. The now negative slope of the forward pricing curve indicates relatively tight inventories with respect to demand and demand expectations. A negatively sloped forward pricing curve is usually accompanied by general price strength. A nearly flat curve indicates a balance in supply, demand, expected supply and expected demand.

The US Dollar decreased on the week exerting upward pressure on petroleum prices, the stock market increased exerting upward pressure on prices while firmer (albeit still very low) petroleum demand kept upward pressure on prices. Overall petroleum inventories experienced an extreme drawdown which kept upward pressure on prices.

Speculation decreased on the week which was negative for 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. The statistical relationship has become stronger in recent weeks.

Weekly US petroleum demand increased by 4.97% on a week over week basis for the week ending December 16th.

Prices remain in the middle 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 maintains the relative attractiveness of adding to short and medium term hedge positions. Longer-term positions can be entered into 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 23rd.

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 16th, total petroleum inventories decreased by 13.36 million barrels vs. a five year average decrease of 3.67 million barrels and vs. an expected decrease of 1.37 million barrels. Inventories decreased by 9.67 million barrels vs. the five year average. Total inventories stand at 681.1 million barrels down from 694.5 million barrels at the end of the previous week. The five year average inventory is 675.4 million barrels, down from 679.1 at the end of the previous week. Current inventories are 0.84% larger than the five year average down from +2.26% at the end of the previous week.

As of December 20th, the net speculative long position in petroleum futures was 249,072,000 barrels down 39,007,000 barrels (-13.54%) from the previous week. This position represents 36.57% of domestic inventories. Speculation is 15.74% below its one year moving average and is 27.61% lower than the 52 week high and slightly lower than the high levels in 2010. The corresponding spot month heating oil futures price on December 20th was 284.98 cents per gallon, down 13.54 cents from 292.88 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 35.04% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 12.27% 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 262.87 cents per gallon or 22.11 cents per gallon less than current prices. The analysis would indicate that about 7.76% 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 decreased several cents on the week. 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.