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Prices Firm - Dollar Strength - Speculation Drops Sharply Again - Strong Inventories
During the week ending March 8th, the spot month heating oil futures price increased by 4.48 cents per gallon (+1.53%) while the deferred months increased by 3 to 5 cent per gallon making the forward pricing curve higher and slightly more negatively sloped. The one year forward price ended the week at a 1.07 cent (0.36%) discount to the spot price, from a discount of 1.01 cents (0.34%) and the end of the previous week.
The change in level and slope of this forward pricing curve indicates higher demand expectations and a decrease in 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 March 8th, the spot month gasoline futures price increased by 7.49 cents per gallon (+2.39%) while the deferred months increased by 8 to 13 cents per gallon making the forward pricing curve higher and generally less negatively sloped. The one year forward price ended the week at a 36.39 cent (12.82%) discount to the spot price, from a discount of 39.18 cents (14.32%) and the end of the previous week.
The change in level and shape of this forward pricing curve indicates higher demand expectations and higher inventory levels with respect to supply and demand.
The US and global economy continued to show signs of improvement while some risk factors persist. Inventories on the week were larger than expected, and remain larger than historical averages. A better economy keeps upward pressure on prices since a more robust economy increases demand and demand expectations. The US Dollar was higher which is negative for price. The stock market was higher which is positive for price. Speculation was lower on the week which was negative for price. The dollar has been driving price for the past month and has been particularly strong versus the Yen and Pound. As the economy improves, the likelihood that the Fed will curtail quantitative easing sooner rather than later increases. Any pull back from QE by the fed due to a stronger economy would be very positive for the dollar and negative for petroleum prices. These financial factors are against a backdrop of fundamental market factors including US domestic crude production at 20 year highs and increasing rapidly.
Weekly US petroleum demand decreased by 2.06% during the week ending March 1st. Demand is up 1.51% vs. one year ago and is 4.50% below the five year average.
The attractiveness of making new hedges decreased slightly on the week given the slightly higher price environment. 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 an average level of competition with speculators for long futures positions and at relatively attractive 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 March 8th.
Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of March 8th.
Factors affecting the market on the period were:
During the week ended March 1st, total petroleum inventories decreased by 0.61 million barrels vs. a five year average decrease of 3.21 million barrels and vs. an expected decrease of 1.80 million barrels. Inventories increased by 2.60 million barrels vs. the five year average. Total inventories stand at 729.6 million barrels, down from 730.2 million barrels at the end of the previous week. The five year average inventory is 707.2 million barrels, down from 710.5 million barrels at the end of the previous week.
Current inventories are 3.16% larger than the five year average up from +2.78% at the end of the previous week, the first increase in eight weeks. Inventories versus the five year average on a percentage basis remain high and steady. This is less negative for price.
As of March 5th, the net speculative long position in petroleum futures was 267,003,000 barrels down 40,122,000 barrels (-13.06%) from the previous week. The level of speculation decreased sharply the second week and represents 36.60% of domestic inventories. Speculation is 1.60% above its one year moving average and is 32.90% below the 52 week high level. Levels have decreased and are returning to more average levels. The corresponding spot month heating oil futures price on March 5th was 297.30 cents per gallon, down 5.87 cents from 303.17 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 83.73% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis over the past year 70.11% 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 240.07 cents per gallon or 57.22 cents per gallon less than current prices. The analysis would indicate that about 19.25% of current price is attributable to speculation and its underlying market rationale. The "would be" price was about 2 cent lower 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 263 million barrels, down by roughly two million barrels 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.