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Petroleum Market Commentary - November 28, 2011

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Lower Prices - Flatter Curve - European Worries - Iran

During the week ending November 25th, the spot month heating oil futures price decreased by 10.52 cents per gallon (-3.47%) while the deferred months decreased by 7 to 9 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 1.75 cent (0.60%) discount to the spot price, down from a discount of 5.16 cents (1.70%) at the end of the previous week.

The change in level and shape of the forward pricing indicates a further decrease in demand expectations and an easing in supply tightness where inventories are more plentiful 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. We saw this effect ease somewhat on the week as the one year slope of the curve neared zero.

The US Dollar increased on the week exerting downward pressure on petroleum prices, the stock market decreased exerting downward pressure on prices while weaker petroleum demand kept downward pressure on prices. Overall petroleum inventories drew down more than expected but not significantly so. This nevertheless supported prices.

Speculation decreased on the week but remains relatively high which 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 decreased by 3.75% on a week over week basis for the week ending November 18th.

Prices have come to the lower portion of the range that they have been in over the last nine months which increases the relative attractiveness of adding to short and medium term hedge positions. Longer-term positions can be entered into as well as this relative price opportunity persists in order to establish some degree of cost certainty in forward periods. Hedging in the short-term at these prices is to capture opportunity in so far as opportunity has not been addressed previously and for the management of budget risk as needed. 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 25th.

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 18th, total petroleum inventories decreased by 2.51 million barrels vs. a five year average increase of 1.32 million barrels and vs. an expected decrease of 0.92 million barrels. Inventories decreased by 3.84 million barrels vs. the five year average. Total inventories stand at 673.4 million barrels down from 675.9 million barrels at the end of the previous week. The five year average inventory is 679.3 million barrels, up from 678.0 at the end of the previous week. Current inventories are 0.87% smaller than the five year average down from -0.31% at the end of the previous week.

As of November 22nd, the net speculative long position in petroleum futures was 285,512,000 barrels down 33,066,000 barrels (-10.38%) from the previous week. This position represents 42.40% of domestic inventories. Speculation levels decreased on the week. The dollar strengthened and economic outlook was less than favorable to support expectations of higher price. Speculation is 3.95% below its one year moving average and is 30% 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 22nd was 303.46 cents per gallon, down 13.67 cents from 317.13 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 27.59 correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis, 7.61% 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. It has, however, stopped declining and has increased slightly in the past several weeks. 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 258.95 cents per gallon or 44.51 cents per gallon less than current prices. The analysis would indicate that about 15% of current price is attributable to speculation and its underlying market rationale. The "would be" price has come up by over $1 per gallon over the past seven 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 297 million barrels.

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.