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Petroleum Market Commentary - March 14, 2012

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Speculation Collapses - Prices Down

During the week ending May 11th, the spot month heating oil futures price decreased by 4.52 cents per gallon (-1.50%) while the deferred months decreased by 4 to 5 cents per gallon making the forward pricing curve lower and unchanged in slope. The one year forward price ended the week at a 4.18 cent (1.41%) premium to the spot price, from a premium of 4.71 cents (1.57%) at the end of the previous week.

The change in level of the forward pricing curve indicates lower demand expectations and steady inventory levels with respect to supply and demand. Demand includes speculative demand which has decreased. The curve remained positively sloped over the next year which is typically associated with more plentiful inventories with respect to demand. Speculation was dramatically lower as of Tuesday the 8th. Speculation has abated causing price to correct.

The US Dollar was stronger again on the week which is negative for petroleum prices. The US stock market decreased again on the week exerting downward 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. This kept upward pressure on prices.

Speculation decreased dramatically during the week as of May 8th to levels below the one year average level of speculation. The statistical relationship between price and speculative levels is high and increased on the week indicating that when prices and level of speculation move quickly, their correlation is high.

Weekly US petroleum demand increased by 0.32% on a week over week basis for the week ending May 4th. Demand is down 0.79% vs. one year ago.

Prices dropped to almost 5 month lows near the middle of the range that we have seen for the past 12 months. This makes incrementally adding to short, medium and long-term hedge positions at these levels relatively attractive. As prices move and as time passes, the advisability of hedging will change. As further price opportunities present themselves, hedging will become more attractive. Entering new, longer-term hedges at these levels would involve less competition with speculators for long futures positions giving a relative advantage to the hedger.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of May 11th.

Factors affecting the market on the week were:

During the week ended May 4th, total petroleum inventories decreased by 2.21 million barrels vs. a five year average increase of 2.15 million barrels and vs. an expected increase of 2.90 million barrels. Inventories decreased by 4.36 million barrels vs. the five year average. Total inventories stand at 707.4 million barrels, down from 709.6 million barrels at the end of the previous week. The five year average inventory is 696.4 million barrels, up from 694.2 at the end of the previous week. Current inventories are 1.58% larger than the five year average down from +2.22% at the end of the previous week. Versus the five year average, inventories continue to be positive.

As of May 8th, the net speculative long position in petroleum futures was 247,359,000 barrels down 94,921,000 barrels (-27.73%) from the previous week. This is a decrease is down to near levels seen on December 20th when prices bottomed the last time. This position represents 34.97% of domestic inventories. Speculation is 15.04% below its one year moving average and is 39.48% below the 52 week high level. Levels have moved down into the range that we saw last summer. The corresponding spot month heating oil futures price on May 8th was 299.01 cents per gallon, down 18.70 cents from 317.71 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 83.67% correlated over the past 52 weeks (a slight increase on the week) indicating that, on a statistical basis, 70.01% 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 245.03 cents per gallon or 53.98 cents per gallon less than current prices. The analysis would indicate that about 18.05% of current price is attributable to speculation and its underlying market rationale. The "would be" price was down 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 291 million barrels. This one year moving average decreased about 2 million barrels on the week as the high levels from last year roll off and as current levels are low. This one year moving average continues to decline.

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.