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Petroleum Market Commentary - January 23, 2012

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Iran, Inventories, and Dollar Support Market

During the week ending January 20th, the spot month heating oil futures price decreased by 3.88 cents per gallon (-1.28%) while the deferred months decreased by 1 to 3 cents per gallon making the forward pricing curve lower and virtually flat. The one year forward price ended the week at a 0.23 cent (0.08%) discount to the spot price, from a discount of 2.15 cents (0.71%) at the end of the previous week.

The change in level and shape of the forward pricing indicates a decrease in demand expectations (some of which is speculative demand due to supply disruption risk) and an increase in inventory levels with respect to supply and demand. The forward pricing curve is virtually flat which means that there is relative balance in the market between supply, demand, and expectations of supply and demand. This includes speculative demand and fear of supply disruption. If fear of supply disruption due to the Iranian situation were lower, the curve would most certainly be positively sloped and lower overall.

The US Dollar decreased on the week exerting upward pressure on petroleum prices, the US stock market increased again exerting upward pressure on prices while lower petroleum demand kept downward pressure on prices. Overall petroleum inventories grew slightly but far below expectations and the five year average which supported price. The market managed to remain relatively elevated due to continued fear of supply disruption from the Iranian situation but finished the week lower as that fear abated somewhat.

Speculation decreased on the week reversing the prior week's increase. This decrease can be attributed mostly to less speculation due to the Iranian situation. A weaker dollar on the week would support higher speculative levels and price. The statistical relationship between price and speculative levels has become stronger in recent weeks suggesting that the relationship is stronger when speculative levels are higher which would be expected.

Weekly US petroleum demand increased by 0.51% on a week over week basis for the week ending January 13th. Demand is down 7.45% vs. one year ago. Some of this decrease in demand has to do with unseasonably warm weather in the Northeast and the specific lack of demand for home heating oil.

Prices have moved back toward the middle of the range that they have been in over the last twelve months. This makes adding to hedge positions at these levels relatively less undesirable but undesirable nevertheless. 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 and become more favorable. As price opportunities present themselves, hedging will become advisable.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of January 20th.

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 January 13th, total petroleum inventories increased by 0.72 million barrels vs. a five year average increase of 8.09 million barrels and vs. an expected increase of 6.73 million barrels. Inventories decreased by 7.37 million barrels vs. the five year average. Total inventories stand at 706.7 million barrels, up from 706.0 million barrels at the end of the previous week. The five year average inventory is 690.9 million barrels, up from 682.8 at the end of the previous week. Current inventories are 2.30% larger than the five year average down from +3.41% at the end of the previous week. Versus the five year average, inventories continue to be positive.

As of January 17th, the net speculative long position in petroleum futures was 293,282,000 barrels down 9,775,000 barrels (-3.23%) from the previous week. This position represents 41.50% of domestic inventories. Speculation is 0.22% below its one year moving average and is 28.18% lower than the 52 week high and at the high levels for 2010. The corresponding spot month heating oil futures price on January 17th was 303.72 cents per gallon, down 6.42 cents from 310.14 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 51.75% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 26.78% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has strengthened in the past month and has become somewhat more relevant. When speculation is due to fear of supply disruption, the relationship tends to be stronger in the short-term. 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 261.17 cents per gallon or 42.55 cents per gallon less than current prices. The analysis would indicate that about 14.01% of current price is attributable to speculation and its underlying market rationale. The "would be" price decreased by less than 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 294 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.