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Prices Higher - Speculation Sharply Lower - Inventories Tighter
During the week ending September 28th, the spot month heating oil futures price increased by 4.87 cents per gallon (+1.56%) while the deferred months increased by 2 to 3 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 16.97 cent (5.35%) discount to the spot price, from a discount of 14.46 cents (4.63%) and the end of the previous week.
The change in level and shape of this forward pricing curve indicates higher demand expectations and lower inventory levels with respect to supply and demand. Demand includes speculative demand which increased again on the week and can be volatile.
During the week ending September 28th, the spot month gasoline futures price increased by 39.95 cents per gallon (+13.58%) while the deferred months increased by 2 to 4 cents per gallon making the forward pricing curve higher and more negatively sloped. The one year forward price ended the week at a 76.06 cent (29.46%) discount to the spot price, from a discount of 38.37 cents (15.00%) and the end of the previous week.
The change in level and shape of this forward pricing curve indicates higher demand expectations and lower inventory levels with respect to supply and demand. It also indicates an unexpected supply shortfall with the sharp increase in the spot price.
Continuing supply disruption fears caused by the Iranian situation and relatively tight inventories with respect to the historical averages have caused the front end of both the heating oil and gasoline curves to increase relative to the far end and for the curve to be negatively sloped. Speculation decreased sharply on the week ended September 25th. The statistical relationship between price and speculative levels remains high.
The US Dollar was higher on the week which is negative for petroleum prices. The US stock market was lower on the week which is negative for petroleum prices. Petroleum demand for the week was slightly lower which kept downward pressure on prices. Overall petroleum inventories decreased vs. expectations and vs. the five-year average keeping upward pressure on prices.
Weekly US petroleum demand decreased by 0.10% during the week ending September 21st. Demand is down 3.36% vs. one year ago.
Short-term hedging became relatively less attractive while longer term hedging is somewhat attractive in light of the historical range of prices and negatively sloped forward pricing curve allowing hedging further into the future at lower prices. Spot prices remain in the top 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 competition with speculators for long futures positions. This is a 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 28th
Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of September 28th.
Factors affecting the market on the period were:
During the week ended September 21st, total petroleum inventories decreased by 3.41 million barrels vs. a five year average decrease of 1.73 million barrels and vs. an expected increase of 3.40 million barrels. Inventories decreased by 1.68 million barrels vs. the five year average. Total inventories stand at 688.8 million barrels, down from 692.2 million barrels at the end of the previous week. The five year average inventory is 686.4 million barrels, down from 688.1 at the end of the previous week. Current inventories are 0.35% larger than the five year average down from +0.59% at the end of the previous week. Versus the five year average, inventories remained positive for the second week.
As of September 25th, the net speculative long position in petroleum futures was 281,519,000 barrels down 37,021,000 barrels (-11.62%) from the previous week. The level of speculation decreased on the week to its lowest level in five weeks but remains relatively high. This position represents 40.87% of domestic inventories. Speculation is 0.59% above its one year moving average and is 31.12% below the 52 week high level. Levels remain near the middle of the range that we have seen over the past two years and are almost at the one year average. The corresponding spot month heating oil futures price on September 25th was 310.86 cents per gallon, down 1.85 cents from 312.71 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 91.15% correlated over the past 52 weeks (slightly lower on the week) indicating that, on a statistical basis over the past year, 83.08% 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 remains high. 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 229.50 cents per gallon or 81.36 cents per gallon less than current prices. The analysis would indicate that about 26.17% of current price is attributable to speculation and its underlying market rationale. The "would be" price has stabilized at the $2.30 level over the past several weeks and was down again 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 280 million barrels, an increased by roughly 2 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.