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Prices Higher - Speculation Sharply Lower - Inventories Tighter
During the week ending October 19th, the spot month heating oil futures price decreased by 8.94 cents per gallon (-2.77%) while the deferred months decreased by 4 to 8 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 14.75 cent (4.71%) discount to the spot price, from a discount of 18.53 cents (5.75%) and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and higher inventory levels with respect to supply and demand. Demand includes speculative demand which increased on the week and can be volatile.
During the week ending October 19th, the spot month gasoline futures price decreased by 19.65 cents per gallon (-6.79%) while the deferred months decreased by 6 to 12 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at an 18.04 cent (7.17%) discount to the spot price, from a discount of 30.67 cents (11.86%) and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and higher inventory levels with respect to supply and demand.
Geopolitical risk continues to support price. Larger than expected inventories on the week were negative for price. The US Dollar and stock market were little changed on the week and had little effect on petroleum prices. Speculation was up on the week which is supportive of price.
Weekly US petroleum demand increased by 4.27% during the week ending October 12th. Demand is down 0.03% vs. one year ago.
Due to price action on the week, short-term hedging became more attractive while longer term hedging became somewhat more 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 diesel 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 but less so than in the recent past. This may be 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 October 19th.
Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of October 19th.
Factors affecting the market on the period were:
During the week ended October 12th, total petroleum inventories increased by 2.36 million barrels vs. a five year average increase of 0.67 million barrels and vs. an expected increase of .050 million barrels. Inventories decreased by 1.69 million barrels vs. the five year average. Total inventories stand at 685.0 million barrels, up from 682.7 million barrels at the end of the previous week. The five year average inventory is 686.7 million barrels, up from 686.0 at the end of the previous week. Current inventories are 0.24% smaller than the five year average up from -0.49% at the end of the previous week. Versus the five year average, inventories remained negative for the third week.
As of October 16th, the net speculative long position in petroleum futures was 287,924,000 barrels up 15,278,000 barrels (+5.60%) from the previous week. The level of speculation increased on the week and remains relatively high. This position represents 42.03% of domestic inventories. Speculation is 1.67% above its one year moving average and is 29.56% 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 October 16th was 319.85 cents per gallon, down 0.47 cents from 320.32 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 88.63% correlated over the past 52 weeks ( lower on the week) indicating that, on a statistical basis over the past year, 78.56% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has weakened in the past several weeks yet 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 230.53 cents per gallon or 89.32 cents per gallon less than current prices. The analysis would indicate that about 27.93% 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 up 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 283 million barrels, an increase of 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.