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Market and Diesel Fuel Hedging Discussion

Dennis Mangan, logi Energy, October 23

Crude Oil:

This week we again saw a rally of $1.97, closing at $80.50. We now have a BUY SIGNAL and should commence hedging. Considering the Crack Spreads, the best place to Hedge is in the Crude Oil. The Indicators changed direction and triggered a Buy Signal. Fundamentally, I am still negative view on the market but I never let my bias about market fundamentals stop me from following the mathematics of the market.

Too many times, I have seen the Indicators be right, and to ignore them is foolish. The market has changed to a bullish scenario after it could not break. The only reason I can clearly see is the weakness in the US $. As long as that continues the market probably cannot break dramatically. When, or if, the US $ strengthens the market should go back down and sharply. A break into the low $70’s, or high $60’s, is probable if we see the $ begin to rally. On the other hand, if dollar weakness continues to be the story we will see higher prices until the weakness finally reverses.

This week product prices rose causing the Gas Crack and 3:2:1 Crack to move higher. The 3:2:1 Crack Spread is above the breakeven price for refineries and this will support the Crude Oil as long as we hold here or higher. Crude Oil will be susceptible to price weakness if the Crack Spreads fail. The Heat Crack Spread dropped 9.82 cpg or 38% over the last 10 weeks as the Gas Crack dropped 27.02 cpg or 68% over the last 12 weeks. The 3:2:1 Crack lost 60% of its value in 10 weeks.

We may be low enough for now on the Crack Spreads but this will be determined by watching inventory and demand. The refiners are about at margins that are breakeven after 5 weeks of losing margins. A number of Refiners have shut down some operations but unless the spreads stay here or higher more will also have to go down. The break started the first week of August and they were making a profit of $7-$8 a barrel, now they are at breakeven and with a huge build up in inventory. Weakness from here in the Crack Spread should signal weakness in Crude Oil. If the 3:2:1 Crack Spread weakens Crude Oil could break severely. We have a lot of Distillate in Inventory and we have too little demand as of now. If we have a mild winter and the Crack Spreads collapse, Crude prices can go back down to $34. A cold winter with increasing demand and better margins will prevent that.

The Vol Price Indicator is at the top of its range for the 7th week in a row, this is bullish. The % Total Count is 80%, rising and this is bullish. The other two Indicators are at 77% and 76%, both rising and this is bullish.

Heating Oil:

We jumped again this week closing at 207.56 cpg up 4.59 cpg. Heating Oil has showed strength over last 4 weeks. This week we generated a BUY SIGNAL but because of the HO Crack spread, we will use Crude Oil for the hedge. Fundamentally, I expect weakness to return, but as of now, the market looks strong. Currently the inventory is huge and demand is small. The Production levels remain too high versus the current demand. Frankly, the demand is simply pathetic. We have inventory 46 million barrels higher than a year ago. Demand remains in the lower 20% of the 10-year range for the last 27 weeks in a row, with production above the 50th Percentile for 24 of the last 27 weeks. Eventually we will see a price problem and a large one if it does not change. Again this may not happen if the US $ remains weak. The facts and the price action continue not to agree, and there is no reason to argue with the price. The fundamental facts appear to be overwhelming negative, yet the price has been going up. The Crack Spread weakened this week but not by much. It must hold these levels, or go higher, or price problems will eventually develop. It all boils down to too much inventory, too much production and too little demand for finished product. This holds true if the US $ recovers more weakness will negate the facts for a while but probably not forever. I cannot see how weakness will not return in the weeks ahead but for now, we will not bet on it. Over the last 62 weeks, we have had only 4 weeks of year over year increases in usage. If Econ 101 is still valid, moving product will ultimately mean a price decrease. That is fine unless this is all the demand that there is. The only way to drop inventory may be a production cut, and a combination of the two will probably be the answer. At some point, it will become clear that if demand does not increase, with production dropping, we will simply not clear this huge inventory. If that plays out, we should expect a price collapse in the Heating Oil and in the HO Crack Spread. If that should happen, expect a decline of 50-75 cpg in Heating Oil and 15-20 cpg in the HO Crack Spread. Remember that this market ran up from 115 to 207 cpg and at the same time inventory built from 145 mm barrels to the all time record highs over 171 mm barrels. Thus, based on those facts, and terrible demand as of now, we can fall right back to where it began. We now have 25+ million barrels in inventory and we are up 92 cpg. If the demand function remains depressed, price will ultimately have a hard time maintaining these levels. When price does turn over the break could be very quick and very large. The Vol Price Indicator is at the top of its range for the 6th week in a row, this is bullish. The % Total Count is 75%, rising and this is bullish. The other two Indicators are at 73% and 74%, one stable and one falling and this is neutral to bullish.

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