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Fiscal Cliff - Lower Prices - Larger Inventories - Speculation Up Slightly
During the week ending December 7th, the spot month heating oil futures price decreased by 14.54 cents per gallon (-4.75%) while the deferred months decreased by 9 to 14 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 0.51 cent (0.17%) discount to the spot price, from a discount of 2.42 cents (0.80%) 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. When the forward pricing curve increases in slope (less negative or more positive), this indicates larger inventories and is generally negative for price.
During the week ending December 7th, the spot month gasoline futures price decreased by 13.29 cents per gallon (-4.87%) while the deferred months increased by 9 to 12 cents per gallon making the forward pricing curve lower and less negatively sloped. The one year forward price ended the week at a 13.01 cent (5.27%) discount to the spot price, from a discount of 20.08 cents (7.84%) and the end of the previous week.
The change in level and shape of this forward pricing curve indicates lower demand expectations and lower inventory levels with respect to supply and demand.
Fear of falling off of the "Fiscal Cliff" continues to ebb and flow as the politicians continue to battle in Washington. The consensus is that something will happen to avoid the automatic tax increases and spending cuts on January 1st. What exactly will be happening is anyone's guess. If for some reason the cliff is not avoided, the economy will be negatively affected and petroleum prices would be weaker. Larger than expected inventories on the week were negative for price. The US Dollar was slightly higher which is negative for price and the stock market was slightly which is positive for price. Speculation was also up on the week supporting price.
Weekly US petroleum demand decreased by 3.33% during the week ending November 30th. Demand is up 2.61% vs. one year ago and remains below the five year average.
The attractiveness of making new hedges increased on the week due to lower prices. The forward pricing curve becoming flatter indicates less speculation and higher inventory levels creating an environment that is more conducive to entering new hedge positions. Spot diesel prices remain near the middle of the 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 less competition with speculators for long futures positions and at relatively attractive prices. Spot heating oil futures in the $2.80 - $2.90 level will trigger additional hedging.
Below is a one year chart of spot heating oil futures prices, the proxy hedging mechanism for diesel fuel, as of December 7th.
Below is a one year chart of spot gasoline futures prices, the hedging mechanism for gasoline, as of December 7th.
Factors affecting the market on the period were:
During the week ended November 30th, total petroleum inventories increased by 8.53 million barrels vs. a five year average increase of 1.00 million barrels and vs. an expected increase of 2.05 million barrels. Inventories increased by 7.53 million barrels vs. the five year average. Total inventories stand at 699.0 million barrels, up from 690.4 million barrels at the end of the previous week. The five year average inventory is 684.9 million barrels, up from 683.9 at the end of the previous week. Current inventories are 2.06% larger than the five year average up from +0.96% at the end of the previous week.
As of December 4th, the net speculative long position in petroleum futures was 230,190,000 barrels up 11,293,000 barrels (+5.16%) from the previous week. The level of speculation increased on the week and represents 29.63% of domestic inventories. Speculation is 15.72% below its one year moving average and is 43.68% below the 52 week high level. Levels remain in the lower half of the range that we have seen over the past two years and lower than the one year average. The corresponding spot month heating oil futures price on December 4th was 300.40 cents per gallon, down 0.54 cents from 300.94 cents per gallon during the previous week.
Heating oil price and size of speculative net long position in petroleum are 83.15% correlated over the past 52 weeks ( lower again on the week) indicating that, on a statistical basis over the past year 69.14% of the price movement of heating oil is explained by changes in levels of speculation. This statistical relationship continues to weaken 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 240.64 cents per gallon or 59.75 cents per gallon less than current prices. The analysis would indicate that about 19.89% of current price is attributable to speculation and its underlying market rationale. The "would be" price is slowly rising, and was up again by less than one cent 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 273 million barrels, a decrease 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.