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Petroleum Market Commentary - June 25, 2012

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Prices Steady - Speculation Lower Again

During the week ending June 22nd, the spot month heating oil futures price decreased by 11.28 cents per gallon (-4.26%) while the deferred months decreased by 8 to 11 cents per gallon making the forward pricing curve lower and more positively sloped over the next year. The one year forward price ended the week at a 7.86 cent (3.10%) premium to the spot price, from a premium of 6.53 cents (2.47%) at the end of the previous week.

The change in level of the forward pricing curve indicates lower demand expectations and more plentiful inventory levels with respect to supply and demand. Demand includes speculative demand which has decreased and can be volatile. 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 June 19th. Speculation continues to fall causing price to decrease as well.

The US Dollar was higher on the week which is negative for petroleum prices. The US stock market decreased on the week exerting downward pressure on prices. Petroleum demand for the week was lower which kept downward pressure on prices. Overall petroleum inventories increased vs. expectations and vs. the five-year average keeping downward pressure on prices.

Speculation decreased during the week as of June 19th. The statistical relationship between price and speculative levels remains high.

Weekly US petroleum demand decreased by 4.15% on a week over week basis for the week ending June 15th. Demand is down 2.16% vs. one year ago.

Prices pushed below the recent low prices to fresh 17+ month lows. This makes incrementally adding to short, medium and long-term hedge positions at these levels 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 June 22nd.

Factors affecting the market on the week were:

During the week ended June 15th, total petroleum inventories increased by 4.96 million barrels vs. a five year average increase of 2.34 million barrels and vs. an expected increase of 1.00 million barrels. Inventories increased by 2.62 million barrels vs. the five year average. Total inventories stand at 711.2 million barrels, up from 706.2 million barrels at the end of the previous week. The five year average inventory is 695.4 million barrels, up from 693.0 at the end of the previous week. Current inventories are 1.90% larger than the five year average down from +1.90% at the end of the previous week. Versus the five year average, inventories continue to be positive.

As of June 19th, the net speculative long position in petroleum futures was 177,288,000 barrels down 6,026,000 barrels (-3.29%) from the previous week. This is the lowest level since September 28, 2010 when price was about 50 cents lower than where it is now. This position represents 24.93% of domestic inventories. Speculation is 36.95% below its one year moving average and is 56.62% below the 52 week high level. Levels have moved down below the low seen briefly last October and to levels not seen since the fall of 2010. The corresponding spot month heating oil futures price on June 19th was 263.51 cents per gallon, up 1.36 cents from 262.15 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 89.47% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 80.04% 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 233.95 cents per gallon or 29.56 cents per gallon less than current prices. The analysis would indicate that about 11.22% of current price is attributable to speculation and its underlying market rationale. The "would be" price continues to decrease and dropped by about 2 cents on the week.

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 281 million barrels. This one year moving average decreased about 1 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.