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Prices Sustained by Speculation - Curve Goes Positive
During the week ending March 9th, the spot month heating oil futures price increased by 6.20 cents per gallon (+1.94%) while the deferred months increased by 6 to 8 cents per gallon making the forward pricing curve higher and slightly positively sloped. The one year forward price ended the week at a 0.40 cent (0.12%) premium to the spot price, from a discount of 1.43 cents (.045%) 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 with respect to supply and demand. The curve became positively sloped which is typically associated with a well-supplied market and one that has more difficulty moving higher. The deferred months continued to move up on a relative basis reflecting ample inventories and slack consumption in spite of supply disruption risk. Typically, the fear of supply disruption causes the curve to become much more negatively sloped. When inventories are plentiful and demand relatively weak, this is not always the case as we are continuing to see.
The US Dollar was higher on the week putting downward pressure on petroleum prices. The US stock market increased slightly exerting slight upward pressure on prices. Petroleum demand for the week was slightly lower which kept downward pressure on prices. Overall petroleum inventories decreased about in line with expectations but by less than the five year average keeping downward pressure on price. The market continued to be sustained at relatively high prices mainly due to the continued fear of supply disruption from the Iranian situation and the accompanying speculative activity.
Speculation fell by about the same amount as the increase during the previous week which leaves them at extremely high levels just not all-time highs. 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 0.43% on a week over week basis for the week ending March 2nd. Demand is down 6.79% vs. one year ago. Gasoline demand remains at multi-year lows indicating the effects of longer-term conservation efforts and a relatively weak economy. The price of gasoline continues to climb in spite of this due to idled refining capacity especially on the East Coast.
Prices remain near the top of the price range that we have seen in the past weeks. 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 continues to support speculative levels and price while the slope of the forward pricing curves suggest that some break in prices may be in the works. 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. In the short-term, this may not be the case.
Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of March 9th.
Factors affecting the market on the week
During the week ended March 2nd, total petroleum inventories decreased by 1.51 million barrels vs. a five year average decrease of 4.90 million barrels and vs. an expected decrease of 1.90 million barrels. Inventories increased by 3.39 million barrels vs. the five year average. Total inventories stand at 714.7 million barrels, down from 716.2 million barrels at the end of the previous week. The five year average inventory is 697.1 million barrels, down from 702.0 at the end of the previous week. Current inventories are 2.54% larger than the five year average up from +2.03% at the end of the previous week. Versus the five year average, inventories continue to be positive.
As of March 6th, the net speculative long position in petroleum futures was 393,218,000 barrels down 15,513,000 barrels (-3.80%) from the previous week. This position represents 55.02% of domestic inventories. Speculation is 31.41% above its one year moving average and is 3.80% below the 52 week high level from last week. Levels are now the same as the highest levels of 2011 during the Libyan crisis. The corresponding spot month heating oil futures price on March 6th was 318.82 cents per gallon, down 3.80 cents from 322.38 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 75.71% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 57.32% 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 and when speculation levels are high, 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 257.36 cents per gallon or 61.46 cents per gallon less than current prices. The analysis would indicate that about 19.28% of current price is attributable to speculation and its underlying market rationale. The "would be" price was down a few cents on the week but continues to be relatively stable in the $2.55 - $2.65 range.
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 299 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.