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Prices Sideways and Range Bound
During the week ending March 16th, the spot month heating oil futures price increased by 1.81 cents per gallon (+0.55%) while the deferred months increased by 0 to 2 cents per gallon making the forward pricing curve higher and now again slightly negatively sloped. The one year forward price ended the week at a 0.81 cent (0.25%) discount to the spot price, from a premium of 0.40 cents (.012%) 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 slight decrease in inventory levels with respect to supply and demand. The curve became slightly negatively sloped which is typically associated with a less well-supplied market while the curve remains relatively flat. The extreme level of speculation continues to sustain prices but is also attracting supply which is tending to keep inventories strong.
The US Dollar was lower on the week putting upward pressure on petroleum prices. The US stock market increased exerting upward pressure on prices. Petroleum demand for the week was slightly higher which kept upward pressure on prices. Overall petroleum inventories decreased by more than expectations and by more than the five year average which kept upward 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 increased slightly during the week but not in excess of the all-time high of two weeks ago. 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 increased by 2.16% on a week over week basis for the week ending March 9th. Demand is down 5.74% vs. one year ago. Gasoline demand remains at multi-year lows indicating the effects of longer-term conservation efforts and a relatively weak economy.
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 especially if Saudi Arabia significantly increases supply in anticipation of a disruption due to Iran. 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 16th.
Factors affecting the market on the week
During the week ended March 9th, total petroleum inventories decreased by 4.34 million barrels vs. a five year average increase of 0.13 million barrels and vs. an expected decrease of 1.20 million barrels. Inventories decreased by 4.47 million barrels vs. the five year average. Total inventories stand at 710.4 million barrels, down from 714.7 million barrels at the end of the previous week. The five year average inventory is 697.2 million barrels, down from 697.1 at the end of the previous week. Current inventories are 1.89% larger than the five year average down from +2.54% at the end of the previous week. Versus the five year average, inventories continue to be positive.
As of March 13th, the net speculative long position in petroleum futures was 397,912,000 barrels up 4,694,000 barrels (+1.19%) from the previous week. This position represents 56.01% of domestic inventories. Speculation is 32.67% above its one year moving average and is 2.65% below the 52 week high level two weeks ago. Levels continue to be sustained at the highest levels of 2011 during the Libyan crisis. The corresponding spot month heating oil futures price on March 13th was 327.12 cents per gallon, up 8.30 cents from 318.82 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 79.28% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 62.85% 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 254.86 cents per gallon or 72.25 cents per gallon less than current prices. The analysis would indicate that about 22.08% of current price is attributable to speculation and its underlying market rationale. The "would be" price was down a few cents on the week and continues to ease lower. This price has remained relatively stable over the past several months.
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 300 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.