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Petroleum Market Commentary - January 9, 2012

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Geopolitical Risk Continues to Support Market - Strong Dollar - Big Inventories

During the week ending January 6th, the spot month heating oil futures price increased by 15.60 cents per gallon (+5.35%) while the deferred months increased by 16 to 18 cents per gallon making the forward pricing curve higher and less negatively sloped. The one year forward price ended the week at a 4.88 cent (3.05%) discount to the spot price, from a discount of 6.16 cents (2.10%) at the end of the previous week.

The change in level and shape of the forward pricing indicates an increase in demand expectations (some of which is speculative demand due to supply disruption risk) and an increase in inventory levels. The negative slope of the forward pricing curve continues to indicate relatively tight inventories with respect to demand and demand expectations. A negatively sloped forward pricing curve is usually accompanied by general price strength.

The US Dollar increased on the week to a one-year high exerting downward pressure on petroleum prices, the stock market increased exerting upward pressure on prices while lower petroleum demand kept downward pressure on prices. Overall petroleum inventories grew unexpectedly and vs. the five year average which kept downward pressure on prices. The market managed to increase significantly due to fear of supply disruption from the Iranian situation despite the usual factors exerting downward pressure on price. When the risk of supply disruption abates, price will correct.

Speculation increased again on the week, mostly due to the Iranian situation, which was positive 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 decreased by 2.57% on a week over week basis for the week ending December 30th. Demand is down 7.34% vs. one year ago. Some of this decrease has to do with unseasonably warm weather in the Northeast.

Prices have moved toward the top of the range that they have been in over the last twelve months. This makes adding to hedge positions at these levels relatively undesirable. Hedging in the short-term at these prices is for the management of budget risk only. 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 January 6th.

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 30th, total petroleum inventories increased by 7.91 million barrels vs. a five year average increase of 2.40 million barrels and vs. an expected increase of 1.00 million barrels. Inventories increased by 5.51 million barrels vs. the five year average. Total inventories stand at 693.5 million barrels up from 685.5 million barrels at the end of the previous week. The five year average inventory is 674.8 million barrels, down from 672.4 at the end of the previous week. Current inventories are 2.44% larger than the five year average up from +1.96% at the end of the previous week. Versus the five year average, inventories are at a three month high.

As of January 3rd, the net speculative long position in petroleum futures was 293,922,000 barrels up 20,524,000 barrels (+7.51%) from the previous week. This position represents 42.38% of domestic inventories. Speculation is 0.26% below its one year moving average and is 28.02% lower than the 52 week high and at the high levels for 2010. The corresponding spot month heating oil futures price on January 3rd was 303.82 cents per gallon, up 12.97 cents from 290.85 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 42.75% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 18.27% 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 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 262.68 cents per gallon or 41.14 cents per gallon less than current prices. The analysis would indicate that about 13.54% 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 increased about one cent on the week and has been relatively stable over the past several months. This would suggest that speculation was ahead of market fundamentals that have now been nearly 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 295 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.