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Speculation Continues Lower - Optimism in Iran
During the week ending April 13th, the spot month heating oil futures price increased by 0.54 cents per gallon (+0.17%) while the deferred months decreased by 0 to 2 cents per gallon making the forward pricing curve slightly negatively sloped. The eleven month forward price ended the week at a 0.92 cent (0.29%) discount to the spot price, from a premium of 1.54 cents (0.49%) 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 negatively sloped which is typically associated with a less 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 continued to abate 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 virtually unchanged on the week having little effect 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 decreased by more than expectations and by more than the five-year average. This kept upward 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. The market is also sustained by an expectation of further quantitative easing by the Federal Reserve which, if it were to occur, would put upward pressure on petroleum prices.
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 second time in two weeks. 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 increased by 4.50% on a week over week basis for the week ending April 6th. Demand is down 4.30% 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 three-month lows during the week indicating that there is price weakness as speculation is down, demand remains weak, and global economic growth prospects remain in question. This makes adding to long-term hedge positions at these levels relatively unattractive while it may be advantageous to add to short and medium-term hedges if needed. Short-term hedging at these prices is also advisable for the management of shorter term 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 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 still 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 13th.
Factors affecting the market on the week
During the week ended April 6th, total petroleum inventories decreased by 5.49 million barrels vs. a five year average decrease of 4.31 million barrels and vs. an expected increase of 0.50 million barrels. Inventories decreased by 1.18 million barrels vs. the five year average. Total inventories stand at 714.7 million barrels, down from 720.2 million barrels at the end of the previous week. The five year average inventory is 691.9 million barrels, down from 696.2 at the end of the previous week. Current inventories are 3.30% larger than the five year average down from +3.45% at the end of the previous week. Versus the five year average, inventories continue to be positive.
As of April 10th, the net speculative long position in petroleum futures was 313,388,000 barrels down 33,229,000 barrels (-9.59%) from the previous week. This position represents 43.85% of domestic inventories. Speculation is 5.45% above its one year moving average and is 23.33% 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 10th was 309.57 cents per gallon, down 13.18 cents from 322.75 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 82.71% correlated over the past 52 weeks (a decrease on the week for the second week in a row) indicating that, on a statistical basis, 68.42% 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 248.90 cents per gallon or 60.67 cents per gallon less than current prices. The analysis would indicate that about 19.60% 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 297 million barrels. This one year moving average decreased about 1 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.