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Petroleum Market Commentary - September 10, 2012

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Prices Steady - Hurricane Shuts In Production - More Quantitative Easing?

During the week ending September 7th, the spot month heating oil futures price decreased by 3.13 cents per gallon (-0.98%) while the deferred months decreased by 0 to 3 cents per gallon making the forward pricing curve lower and generally less negatively sloped over the next two years. The one year forward price ended the week at an 8.55 cent (2.72%) discount to the spot price, from a discount of 10.03 cents (3.16%) and the end of the previous week.

The change in level and shape of the forward pricing curve indicates lower demand expectations and relatively more plentiful inventory levels with respect to supply and demand. Demand includes speculative demand which increased slightly on the week and can be volatile. Supply disruption fears caused by the Iranian situation and relatively tight inventories with respect to the historical averages, have caused the front end of the curve to increase relative to the far end and for the curve to be negatively sloped. Speculation increased slightly on the week ended September 4th and is now over the one year moving average level. The statistical relationship between price and speculative levels remains high.

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

Weekly US petroleum demand decreased by 0.91% during the week ending August 31st. Demand is down 1.00% vs. one year ago.

Prices were relatively stable during the period while shorter term hedging remains less attractive while longer term hedging remains relatively attractive in light of the historical range of prices. Spot prices are at the upper quintile 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 September 7th.

Factors affecting the market on the period were:

During the week ended August 31st, total petroleum inventories decreased by 8.77 million barrels vs. a five year average decrease of 2.79 million barrels and vs. an expected decrease of 10.00 million barrels. Inventories decreased by 5.98 million barrels vs. the five year average. Total inventories stand at 683.1 million barrels, down from 691.8 million barrels at the end of the previous week. The five year average inventory is 694.3 million barrels, down from 697.1 at the end of the previous week. Current inventories are 1.62% smaller than the five year average down from -0.76% 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 September 4th, the net speculative long position in petroleum futures was 292,953,000 barrels up 4,828,000 barrels (+1.68%) from the previous week. The level of speculation increased slightly on the week and remains at the levels seen in early May. This position represents 42.89% of domestic inventories. Speculation is 6.21% above its one year moving average and is 28.33% 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 September 4th was 314.68 cents per gallon, up 2.65 cents from 312.03 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 91.47% correlated over the past 52 weeks (unchanged on the week) indicating that, on a statistical basis, 83.67% 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 prices have been relatively more volatile. 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 230.74 cents per gallon or 83.94 cents per gallon less than current prices. The analysis would indicate that about 26.67% 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 and was 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 276 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.