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Petroleum Market Commentary - August 20, 2012

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Prices Higher - Negative Curve - Iran

During the week ending August 17th, the spot month heating oil futures price increased by 7.21 cents per gallon (+2.39%) while the deferred months increased by 1 to 7 cents per gallon making the forward pricing curve higher and generally more negatively sloped over the next two years. The one year forward price ended the week at a 6.75 cent (2.18%) discount to the spot price, from a discount of 2.43 cents (0.80%) at the end of the previous week.

The change in level and shape of the forward pricing curve indicates higher demand expectations and relatively less plentiful inventory levels with respect to supply and demand. Demand includes speculative demand which has increased 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 decreased slightly on the week as of Tuesday August 14th. Speculation levels remained relatively unchanged on the week.

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

Speculation decreased slightly the week ending August 14th. The statistical relationship between price and speculative levels remains high.

Weekly US petroleum demand increased by 5.70% on a week over week basis for the week ending August 10th. Demand is down 0.74% vs. one year ago.

Prices increased during the week to levels that make shorter term hedging less attractive while longer term hedging remains relatively attractive in light of the historical range of prices. Spot prices are nearing the upper quartile of the 80 cent price range that we have seen over the past twelve months. 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 relatively more competition with speculators for long futures positions as speculative levels have risen somewhat. This is a relative disadvantage to the hedger.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of August 17th.

Factors affecting the market on the week were:

During the week ended August 10th, total petroleum inventories decreased by 5.39 million barrels vs. a five year average decrease of 4.48 million barrels and vs. an expected decrease of 4.15 million barrels. Inventories decreased by 0.92 million barrels vs. the five year average. Total inventories stand at 694.1 million barrels, down from 699.5 million barrels at the end of the previous week. The five year average inventory is 696.1 million barrels, down from 700.6 at the end of the previous week. Current inventories are 0.29% smaller than the five year average down from -0.16% at the end of the previous week. Versus the five year average, inventories are now negative. While this is supportive of price, lower inventories are also due to lower demand which is negative for price.

As of August 14th, the net speculative long position in petroleum futures was 237,398,000 barrels down 1,024,000 barrels (-0.43%) from the previous week. The level of speculation has stabilized at levels seen in early May. This position represents 34.20% of domestic inventories. Speculation is 13.03% below its one year moving average and is 41.92% below the 52 week high level. Levels have returned to near the middle of the range that we have seen over the past two years. The corresponding spot month heating oil futures price on August 14th was 303.46 cents per gallon, up 3.66 cents from 299.80 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 91.22% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis, 83.21% 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 become lower, 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 232.72 cents per gallon or 70.74 cents per gallon less than current prices. The analysis would indicate that about 23.31% of current price is attributable to speculation and its underlying market rationale. The "would be" price has stabilized at the $2.33 level over the past several weeks and down slightly 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 273 million barrels, an increased by roughly 1 million barrels on the week.

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.