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Petroleum Market Commentary - December 5, 2011

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Higher Prices - Flatter Curve - Big Inventories

During the week ending December 2nd, the spot month heating oil futures price increased by 4.95 cents per gallon (+1.68%) while the deferred months increased by 6 to 8 cents per gallon making the forward pricing curve higher and practically flat. The one year forward price ended the week at a 0.42 cent (0.14%) premium to the spot price, from a discount of 1.75 cents (0.60%) at the end of the previous week.

The change in level and shape of the forward pricing indicates an increase in demand expectations as the European situation has improved indicated by the rise in the stock market and a further easing in supply tightness where inventories grew much more than expected and 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 continue on the week as the one year slope of the curve went slightly positive.

The US Dollar decreased on the week exerting upward pressure on petroleum prices, the stock market increased significantly exerting upward pressure on prices while continued weaker petroleum demand kept downward pressure on prices. Overall petroleum inventories increased much more than expected which kept prices in check. It is interesting to note that while the stock market increased significantly, petroleum did not also have a big increase.

Speculation decreased slightly 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 3.44% on a week over week basis for the week ending November 25th to its lowest level since June 2009. The news here is that markets work. High prices eventually bring more supply and curtail demand and stabilize or lower prices.

Prices are in the middle of the range that they have been in over the last nine months which decreases the relative attractiveness of adding to short and medium term hedge positions. Longer-term positions can be entered into but only in smaller percentages 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 December 2nd.

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 25th, total petroleum inventories increased by 9.67 million barrels vs. a five year average increase of 2.85 million barrels and vs. an expected increase of 0.25 million barrels. Inventories increased by 6.82 million barrels vs. the five year average. Total inventories stand at 683.1 million barrels up from 673.4 million barrels at the end of the previous week. The five year average inventory is 682.2 million barrels, up from 679.3 at the end of the previous week. Current inventories are 0.13% larger than the five year average up from -0.87% at the end of the previous week.

As of November 29th, the net speculative long position in petroleum futures was 281,741,000 barrels down 3,771,000 barrels (-1.32%) from the previous week. This position represents 41.25% of domestic inventories. Speculation levels decreased again on the week. Inventories grew and so the outlook was less than favorable to support expectations of higher price. Speculation is 5.38% below its one year moving average and is 31% 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 29nd was 302.11 cents per gallon, down 1.35 cents from 303.46 cents per gallon during the previous week.

Heating oil price and size of speculative net long position in petroleum are 25.51% correlated over the past 52 weeks (a decrease on the week) indicating that, on a statistical basis, 6.51% 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 264.66 cents per gallon or 37.45 cents per gallon less than current prices. The analysis would indicate that about 12.4% 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 298 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.