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Prices Remain Elevated: Iran, Economic Optimism, and Domestic Demand at 12-year Low
During the week ending February 10th, the spot month heating oil futures price increased by 6.77 cents per gallon (+2.17%) while the deferred months increased by 5 to 7 cents per gallon making the forward pricing curve higher and slightly more negatively sloped. The one year forward price ended the week at a 5.21 cent (1.64%) discount to the spot price, from a discount of 4.20 cents (1.35%) 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 a decrease in inventory levels with respect to supply and demand. The curve became more negatively sloped despite the larger than expected builds in inventory levels indicating a relative up-tick in geopolitical tensions being priced into the market through increased speculative pressures.
The forward pricing curve is negatively sloped which means that there is relative tightness of supply with respect to supply and demand expectations. 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 likely be positively sloped and lower overall given current levels of inventory and levels of demand and expected demand.
The US Dollar was slightly stronger on the week putting slight downward pressure on petroleum prices. The US stock market increased slightly exerting slight upward pressure on prices while lower petroleum demand for the week kept downward pressure on prices. Overall petroleum inventories grew more than expectations but less than the five year average. This was generally negative for price. The market managed to remain relatively elevated due to continued fear of supply disruption from the Iranian situation.
Speculation increased on the week supporting prices. The statistical relationship between price and speculative levels has continued to become stronger in recent weeks suggesting that the relationship is stronger when speculative levels are higher, which would be expected.
Weekly US petroleum demand decreased by 0.49% on a week over week basis for the week ending February 3rd. Demand is down 4.97% 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. However, gasoline demand is at an 11- year low indicating the effects of longer-term conservation efforts and a relatively weak economy.
Prices have remained steady at the high end of the range that they have seen in over the last twelve months. This makes adding to hedge positions at these levels unattractive. 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. Currently, the Iranian situation is supporting speculative levels and price. Entering new, longer-term hedges at these levels would involve competing with speculators for long futures positions which would most likely prove disadvantageous in the long-term.
Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of February 10th.
Factors affecting the market on the week
During the week ended February 3rd, total petroleum inventories increased by 3.11 million barrels vs. a five year average increase of 4.31 million barrels and vs. an expected increase of 2.25 million barrels. Inventories decreased by 1.21 million barrels vs. the five year average. Total inventories stand at 717.6 million barrels, up from 714.5 million barrels at the end of the previous week. The five year average inventory is 704.2 million barrels, up from 699.9 at the end of the previous week. Current inventories are 1.91% larger than the five year average up from +2.09% at the end of the previous week. Versus the five year average, inventories continue to be positive.
As of February 7th, the net speculative long position in petroleum futures was 333,775,000 barrels up 15,044,000 barrels (+4.72%) from the previous week. This position represents 46.51% of domestic inventories. Speculation is 12.86% above its one year moving average and is 18.27% lower than the 52 week high and above the high levels for 2010. The corresponding spot month heating oil futures price on February 7th was 319.09 cents per gallon, up 12.81 cents from 306.28 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 60.17% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 36.20% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has strengthened in the past several months and continues to become 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 263.10 cents per gallon or 55.99 cents per gallon less than current prices. The analysis would indicate that about 17.55% of current price is attributable to speculation and its underlying market rationale. The "would be" price was again virtually unchanged on the week and continues to be relatively stable.
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.