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Petroleum Market Commentary - March 28, 2012

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Iranian Situation Improves - Prices Steady

During the week ending May 25th, the spot month heating oil futures price decreased by 0.12 cents per gallon (-0.04%) while the deferred months varied between up one cent and down one cent making the forward pricing curve virtually unchanged in level and shape. The one year forward price ended the week at a 6.39 cent (2.26%) premium to the spot price, from a premium of 6.50 cents (2.30%) at the end of the previous week. Price for the newly created 2015 futures contracts were adjusted downward to more accurately reflect market conditions.

The change in level of the forward pricing curve indicates little change in demand expectations and little change in 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 lower again as of Tuesday the 22nd. 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 increased on the week exerting upward pressure on prices. Petroleum demand for the week was slightly lower which kept downward 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 during the week as of May 22nd. The statistical relationship between price and speculative levels remains high and continues to become stronger.

Weekly US petroleum demand decreased by 1.74% on a week over week basis for the week ending May 18th. Demand is up 1.24% vs. one year ago.

Prices remained at a 5 month low which is near the bottom 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 25th.

Factors affecting the market on the week were:

During the week ended May 18th, total petroleum inventories decreased by 2.73 million barrels vs. a five year average decrease of 0.55 million barrels and vs. an expected increase of 1.50 million barrels. Inventories decreased by 2.17 million barrels vs. the five year average. Total inventories stand at 703.0 million barrels, down from 705.8 million barrels at the end of the previous week. The five year average inventory is 694.9 million barrels, down from 695.5 at the end of the previous week. Current inventories are 1.16% larger than the five year average down from +1.47% at the end of the previous week. Versus the five year average, inventories continue to be positive.

As of May 22nd, the net speculative long position in petroleum futures was 219,796,000 barrels down 9,724,000 barrels (-4.24%) from the previous week. This is the lowest level since October 11th when price was about where it is now. This position represents 31.26% of domestic inventories. Speculation is 23.72% below its one year moving average and is 46.22% 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 22nd was 286.14 cents per gallon, down 7.16 cents from 293.30 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 88.60% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 78.50% 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 has become stronger as the level of speculation has fallen rapidly, and continues to be significant. 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 244.38 cents per gallon or 41.76 cents per gallon less than current prices. The analysis would indicate that about 14.60% of current price is attributable to speculation and its underlying market rationale. The "would be" price continues to decrease slowly.

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 288 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.