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Petroleum Market Commentary - April 23, 2012

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Relative Calm

During the week ending April 20th, the spot month heating oil futures price decreased by 3.70 cents per gallon (-1.17%) while the deferred months decreased by 3 to 4 cents per gallon making the forward pricing curve virtually flat. The eleven month forward price ended the week at a 0.01 cent (0.01%) discount to the spot price, from a discount of 0.92 cents (0.29%) 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 curve indicates slightly lower demand expectations and a slight increase in inventory levels with respect to supply and demand. The curve became flat which is typically associated with a market where expectations of supply and demand are balanced. The level of speculation continues to sustain prices but is also attracting supply which is tending to keep inventories strong. Speculation has decreased in the past month but experienced a slight increase on the week. The Iranian situation continues to support speculative levels as does an expectation of further quantitative easing from the Federal Reserve which would weaken the dollar and support petroleum prices.

The US Dollar was weaker on the week which is supportive of petroleum prices. The US stock market increased exerting upward 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.

Speculation increased during the week for the first time in five weeks and still remains at high levels from a historical perspective. The statistical relationship between price and speculative levels is high but decreased slightly on the week. 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 0.75% on a week over week basis for the week ending April 13th. Demand is down 2.70% vs. one year ago.

Prices remained at the lower end of the range for the past two months and the higher end of the range for the past 14 months. 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. Entering new, longer-term hedges at these levels would still involve competing with speculators for long futures positions which may 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 20th.

Factors affecting the market on the week were:

During the week ended April 13th, total petroleum inventories decreased by 2.72 million barrels vs. a five year average decrease of 0.76 million barrels and vs. an expected increase of 0.60 million barrels. Inventories decreased by 1.96 million barrels vs. the five year average. Total inventories stand at 712.0 million barrels, down from 714.7 million barrels at the end of the previous week. The five year average inventory is 691.1 million barrels, down from 691.9 at the end of the previous week. Current inventories are 3.02% larger than the five year average down from +3.30% at the end of the previous week. Versus the five year average, inventories continue to be positive.

As of April 17th, the net speculative long position in petroleum futures was 318,040,000 barrels up 4,652,000 barrels (+1.48%) from the previous week. This position represents 44.67% of domestic inventories. Speculation is 7.49% above its one year moving average and is 22.19% below the 52 week high level. Levels have come below the levels seen in early 2011 during the Libyan crisis and are roughly where they were three months ago. The corresponding spot month heating oil futures price on April 17th was 312.66 cents per gallon, up 3.09 cents from 309.57 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 82.64% correlated over the past 52 weeks (a slight decrease on the week for the second week in a row) indicating that, on a statistical basis, 68.29% 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, has stabilized as the level of speculation has fallen, 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 248.09 cents per gallon or 64.57 cents per gallon less than current prices. The analysis would indicate that about 20.65% of current price is attributable to speculation and its underlying market rationale. The "would be" price was down slightly again 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 296 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.