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Petroleum Market Commentary - July 23, 2012

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Curve Goes Negative - Iran

During the week ending July 20th, the spot month heating oil futures price increased by 13.61 cents per gallon (+4.88%) while the deferred months increased by 6 to 13 cents per gallon making the forward pricing curve higher and negatively sloped over the next year. The one year forward price ended the week at a 2.66 cent (0.91%) discount to the spot price, from a premium of 0.81 cents (0.29%) at the end of the previous week.

The change in level of the forward pricing curve indicates higher demand expectations and less plentiful inventory levels with respect to supply and demand. Demand includes speculative demand (and lack of speculative short positions) which has decreased and can be volatile. Supply disruption fears caused by the Iranian situation have caused the front end of the curve to increase relative to the far end and for the curve to be negatively sloped. This is due to the increased possibility of lower inventories caused by supply disruption in the short-term. Speculation increased slightly on the week as of Tuesday July 17th. Speculation levels have stabilized in the past weeks while prices have advanced.

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

Speculation increased during the week ending July 17th. The statistical relationship between price and speculative levels remains high.

Weekly US petroleum demand increased by 0.33% on a week over week basis for the week ending July 13th. Demand is up 0.43% vs. one year ago.

Prices increased during the week to levels that remain attractive for short and medium-term hedging in light of the historical range of prices, and less attractive for long-term hedges. Prices are about in the middle of their twelve month range. 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 July 20th.

Factors affecting the market on the week were:

During the week ended July 13th, total petroleum inventories decreased by 0.05 million barrels vs. a five year average increase of 2.38 million barrels and vs. an expected increase of 1.35 million barrels. Inventories decreased by 2.38 million barrels vs. the five year average. Total inventories stand at 706.8 million barrels, unchanged from the previous week. The five year average inventory is 697.6 million barrels, up from 695.2 at the end of the previous week. Current inventories are 1.33% larger than the five year average down from +1.67% at the end of the previous week. Versus the five year average, inventories continue to be positive.

As of July 17th, the net speculative long position in petroleum futures was 181,803,000 barrels up 3,467,000 barrels (+1.94%) from the previous week. The level of speculation has stabilized and has stopped decreasing over the past several weeks. This position represents 25.72% of domestic inventories. Speculation is 33.90% below its one year moving average and is 55.52% below the 52 week high level. Levels have stabilized and remained at levels not seen since the fall of 2010. The corresponding spot month heating oil futures price on July 17th was 284.22 cents per gallon, up 12.27 cents from 271.95 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 91.00% correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 82.80% 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 231.40 cents per gallon or 52.82 cents per gallon less than current prices. The analysis would indicate that about 18.58% of current price is attributable to speculation and its underlying market rationale. The "would be" price has stabilized at the $2.31 level over the past several weeks.

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 275 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.