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Higher Speculation - Higher Prices - Higher Inventories
During the week ending February 8th, the spot month heating oil futures price increased by 7.78 cents per gallon (+2.46%) while the deferred months increased by 2 to 6 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 12.44 cent (3.84%) discount to the spot price, from a discount of 7.83 cents (2.48%) and the end of the previous week.
The change in level and slope of this forward pricing curve indicates increased demand expectations and tighter supplies with respect to demand. Demand includes speculative demand which increased again on the week and can be volatile. 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.
During the week ending February 8th, the spot month gasoline futures price increased by 0.52 cents per gallon (+0.17%) while the deferred months increased by 2 to 6 cents per gallon making the forward pricing curve higher and more negatively sloped except for the spot month. The one year forward price ended the week at a 30.98 cent (11.27%) discount to the spot price, from a discount of 34.72 cents (12.83%) and the end of the previous week.
The change in level and shape of this forward pricing curve indicates generally higher demand expectations and lower inventory levels with respect to supply and demand.
The US and global economy continue to show signs of improvement and economic risks continue to decrease. Inventories on the week were larger than expected and remain larger than historical averages. This keeps downward pressure on price. The US Dollar was higher which is negative for price. The stock market was higher which is positive for price. Speculation was up on the week which is supportive of price.
Weekly US petroleum demand increased by 0.19% during the week ending January 25th. Demand is up 0.52% vs. one year ago and is 5.26% below the five year average.
The attractiveness of making new hedges continues to decrease since prices and speculation were higher again on the week. Spot diesel prices continued to increase to new four month high prices near the top of the range that we have seen over the past several years. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging will become more attractive. Entering new, longer-term hedges at these levels would involve more competition with speculators for long futures positions and at somewhat unattractive prices. Spot heating oil futures in the $2.80 - $2.90 level will trigger additional hedging.
Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of February 8th.
Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of February 8th.
Factors affecting the market on the period were:
During the week ended February 1st, total petroleum inventories increased by 3.32 million barrels vs. a five year average increase of 5.23 million barrels and vs. an expected increase of 2.93 million barrels. Inventories decreased by 1.91 million barrels vs. the five year average. Total inventories stand at 735.3 million barrels, up from 732.0 million barrels at the end of the previous week. The five year average inventory is 710.1 million barrels, up from 704.9 at the end of the previous week.
Current inventories are 3.55% larger than the five year average down from +3.85% at the end of the previous week. Inventories versus the five year average on a percentage basis continue to be near eighteen month highs. This is negative for price and mitigates the effects of more speculation.
As of February 5th, the net speculative long position in petroleum futures was 339,912,000 barrels up 3,966,000 barrels (+1.18%) from the previous week. The level of speculation increased for the eighth straight week and represents 45.68% of domestic inventories, less as a percentage of domestic inventories due to the growth in inventories. Speculation is 26.84% above its one year moving average and is 16.84% below the 52 week high level. Levels have increased above the middle of the range that we have seen over the past two years, have become higher than the one year average, and are at the highest level since May 1, 2012. The corresponding spot month heating oil futures price on February 5th was 319.13 cents per gallon, up 8.21 cents from 310.92 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 83.39% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 69.54% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has stabilized and remains high. 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 244.80 cents per gallon or 74.33 cents per gallon less than current prices. The analysis would indicate that about 23.29% of current price is attributable to speculation and its underlying market rationale. The "would be" price was steady on the week.
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 268 million barrels, roughly unchanged on the week.
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.