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Petroleum Market Commentary - November 14, 2011

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Inventories Below Five Year Average - Prices Near 7-Month Highs

During the week ending November 11th, the spot month heating oil futures price increased by 10.09 cents per gallon (+3.29%) while the deferred months increased by 8 to 11 cents per gallon making the forward pricing curve higher and generally more negatively sloped. The one year forward price ended the week at an 11.40 cent (3.59%) discount to the spot price, down from a discount of 9.73 cents (3.17%) at the end of the previous week.

The change in level of the forward pricing indicates an increase in demand expectations while the change in the slope of the curve indicates decline in inventory with respect to demand expectations. A negatively sloped forward pricing curve indicates relative tightness in supply with respect to demand and inventories. This is usually accompanied by general price support.

The US Dollar decreased very slightly on the week exerting very small upward pressure on petroleum prices, the stock market increased exerting upward pressure on prices while stronger petroleum demand and the larger than expected decrease in inventories kept upward pressure on prices.

Speculation decreased for the first time in a month but only by 1.42% which is relatively unchanged on the week. The speculative demand kept upward pressure on prices despite a stronger dollar. Speculative activity is supportive of price. As the level of speculation decreases, price and speculative levels continue to become less linked suggesting that the linkage is stronger when speculation levels are extreme.

Weekly US petroleum demand increased by 7.49% on a week over week basis for the week ending November 4th.

Prices remain in the upper portion of the range that we have seen for the past nine months which decreases the attractiveness of adding to short and medium term hedge positions. Longer-term positions can be entered into incrementally but in small amounts in order to establish some degree of cost certainty in forward periods. Hedging in the short-term at these prices should be for the management of budget risk only. As prices move and as time passes, the advisability of medium to longer-term hedging will change.

Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of November 11th.

Factors affecting the market on the week

Macro factors:

US economic data and news including:

Global economic data and news including:

During the week ended November 4th, total petroleum inventories decreased by 9.50 million barrels vs. a five year average decrease of 1.50 million barrels and vs. an expected decrease of 1.00 million barrels. Inventories decreased by 8.00 million barrels vs. the five year average. Total inventories stand at 678.1 million barrels down from 687.6 million barrels at the end of the previous week. The five year average inventory is 681.2 million barrels, down from 682.7 at the end of the previous week. Current inventories are 0.45% smaller than the five year average down from +0.72% at the end of the previous week.

As of November 8th, the net speculative long position in petroleum futures was 305,392,000 barrels up 16,692,000 barrels (+5.78%) from the previous week. This position represents 45.03% of domestic inventories. Speculation levels increased on the week indicating an increase in the investment appetite for petroleum as speculators reacted to the surprise drop in inventories especially in distillate inventories causing heating oil prices to outperform gasoline and crude. Speculation is 3% above its one year average and is 24% lower than the peaks we saw earlier this year and roughly at the levels we saw in early 2010. The corresponding spot month heating oil futures price on November 8th was 311.61 cents per gallon, up 7.82 cents from 303.79 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 29.73 correlated over the past 52 weeks (an increase on the week) indicating that, on a statistical basis, 8.84% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship has continued to be weak over the past few months and, considering the past year's data, has become somewhat irrelevant but is worth monitoring as an indicator of how the hedger is competing with the speculator for forward pricing. 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 249.71 cents per gallon or 61.90 cents per gallon less than current prices. The analysis would indicate that about 20% of current price is attributable to speculation and its underlying market rationale. The "would be" price has come up about $1 per gallon over the past six months and the percent of price attributable to speculation has decreased. This would suggest that speculation was ahead of market fundamentals that have now been realized.

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 296 million barrels.

The graph below is three year history of speculative position levels.