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Curve Positive & Lower - Market Weakness
During the week ending March 23rd, the spot month heating oil futures price decreased by 7.18 cents per gallon (-2.19%) while the deferred months decreased by 4 to 7 cents per gallon making the forward pricing curve lower and now again slightly positively sloped. The one year forward price ended the week at a 1.68 cent (0.52%) premium to the spot price, from a discount of 0.81 cents (0.25%) at the end of the previous week.
The change in level and shape of the forward pricing indicates a decrease in demand expectations (some of which is speculative demand due to supply disruption risk) and a slight increase in inventory levels with respect to supply and demand. The curve became slightly positively sloped which is typically associated with a well-supplied market. 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 decreased exerting downward pressure on prices. Petroleum demand for the week was lower which kept downward pressure on prices. Overall petroleum inventories decreased by less than expectations and by less than the five-year average which kept downward pressure on prices. The market continues 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 decreased during the week allowing prices to go lower yet remains at extremely high levels. 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 4.83% on a week over week basis for the week ending March 16th. Demand is down 5.81% 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 high but in the lower half of the range that we have seen over the past six weeks. This makes adding to long-term hedge positions at these levels unattractive while it may be advantageous to add to very short-term hedges if needed. Short-term hedging at these prices may also be advisable for the management of budget risk. As prices move and as time passes, the advisability of medium to longer-term hedging will change and may 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 23rd.
Factors affecting the market on the week
During the week ended March 16th, total petroleum inventories decreased by 0.62 million barrels vs. a five year average decrease of 1.59 million barrels and vs. an expected decrease of 1.15 million barrels. Inventories increased by 0.98 million barrels vs. the five year average. Total inventories stand at 709.8 million barrels, down from 710.4 million barrels at the end of the previous week. The five year average inventory is 695.6 million barrels, down from 697.2 at the end of the previous week. Current inventories are 2.04% larger than the five year average up from +1.89% at the end of the previous week. Versus the five year average, inventories continue to be positive.
As of March 20th, the net speculative long position in petroleum futures was 381,796,000 barrels down 16,116,000 barrels (-4.05%) from the previous week. This position represents 53.79% of domestic inventories. Speculation is 27.29% above its one year moving average and is 6.59% below the 52 week high level three 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 20th was 323.67 cents per gallon, down 3.45 cents from 327.12 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 80.73% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 65.18% 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 253.14 cents per gallon or 70.53 cents per gallon less than current prices. The analysis would indicate that about 21.79% of current price is attributable to speculation and its underlying market rationale. The "would be" price was down slightly on the week and continues to ease lower.
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.