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Lower Prices - Lower Speculation Again
During the week ending April 6th, the spot month heating oil futures price decreased by 0.09 cents per gallon (-0.03%) while the deferred months increased by 0 to 2 cents per gallon making the forward pricing curve virtually unchanged in level and positively sloped. The eleven month forward price ended the week at a 1.54 cent (0.49%) premium to the spot price, from a discount of 0.26 cents (0.08%) at the end of the previous week. The curve remains virtually flat on a year over year basis.
The change in level and shape of the forward pricing indicates little change 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 positively sloped which is typically associated with a more well-supplied market. The level of speculation continues to sustain prices but is also attracting supply which is tending to keep inventories strong. Speculation has abated in the past several weeks due to growth in inventories and due to positive or at least not negative developments in the Iranian situation.
The US Dollar was significantly higher on the week putting downward pressure on petroleum prices. The US stock market decreased exerting downward pressure on prices. Petroleum demand for the week was higher which kept upward pressure on prices. Overall petroleum inventories increased by more than expectations and by more than the five-year average keeping 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 while the speculative activity abated somewhat.
Speculation decreased again during the week allowing prices to go lower yet remains at extremely high levels. The statistical relationship between price and speculative levels is high but decreased for the first time in several months. This would be expected as the level of speculation has decreased over the past several weeks. The correlation between price and level of speculation is stronger when speculation levels and prices are higher.
Weekly US petroleum demand decreased by 0.10% on a week over week basis for the week ending March 30th. Demand is down 4.69% 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 achieved seven-week lows during the week indicating that there is price weakness as inventories grow, demand remains weak, and global economic growth prospects remain in question. 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 speculation albeit at slightly lower levels. The slope of the forward pricing curve suggests 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 which appears to be the case. 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 April 6th.
Factors affecting the market on the week
During the week ended March 30th, total petroleum inventories increased by 7.57 million barrels vs. a five year average increase of 0.33 million barrels and vs. an expected increase of 0.55 million barrels. Inventories increased by 7.24 million barrels vs. the five year average. Total inventories stand at 720.2 million barrels, up from 712.6 million barrels at the end of the previous week. The five year average inventory is 696.2 million barrels, up from 695.8 at the end of the previous week. Current inventories are 3.41% larger than the five year average up from +2.41% at the end of the previous week. Versus the five year average, inventories continue to be positive and are the highest vs. five year average since September 23rd.
As of April 3rd, the net speculative long position in petroleum futures was 346,617,000 barrels down 27,481,000 barrels (-7.35%) from the previous week. This position represents 48.13% of domestic inventories. Speculation is 16.14% above its one year moving average and is 15.20% below the 52 week high level. Levels have come below the levels seen in early 2011 during the Libyan crisis. The corresponding spot month heating oil futures price on April 3rd was 322.75 cents per gallon, up 0.89 cents from 321.86 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 83.01% correlated over the past 52 weeks (a decrease on the week for the first time in a number of months) indicating that, on a statistical basis, 68.92% 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 be significant. 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 249.17 cents per gallon or 73.58 cents per gallon less than current prices. The analysis would indicate that about 22.80% of current price is attributable to speculation and its underlying market rationale. The "would be" price was down on the week and continues to move 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 298 million barrels. This one year moving average decreased about 2 million barrels on the week as the high levels from last year roll off.
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.