As the industry ramps up for the 2012-2013 heating season, Fuel Oil News asked some experts in both fuel price analysis and the weather what our readers can expect. The general consensus is that heating oil prices should remain fairly consistent overall, though, there are factors that could drive prices much higher or potentially much lower. The winter should almost certainly be better for fuel sales.
Crude oil prices set the overwhelming basis for the price of refined products. According to the U.S. Energy Information Administration Brent crude oil prices are expected to fall from recent highs over the rest of 2012, averaging $111 per barrel over the last 4 months of 2012 and $103 per barrel in 2013.
Brian Milne, Telvent DTN’s refined fuels editor predicts prices generally inline with EIA’s estimates though perhaps lower during the heating season. “We should pop over $100 maybe go up in the $110 (per bbl.) area during the fourth quarter if we start seeing a little better growth in the fourth quarter. What takes place in North Africa is going to be important, that geopolitical risk getting funneled back into the price of oil and what goes on with Iran and Israel.”
Milne noted that if tensions calm and the economy remains stagnant, prices will probably fall back into the $90 or even $80 range.
As noted turmoil in the Middle East could push prices much higher. Fuel Oil News recently interviewed the host of FOX Business Network’s MONEY with Melissa Francis on the preparedness of the U.S. military to handle potential Iranian hostilities in the Strait of Hormuz. Francis has just completed a tour of the region as part of a broader look at the ramifications of such an event. When the impact of such an even on crude prices was discussed, she noted: “The government General Accounting Office thinks that the price of oil would spike right away to $175 per barrel. I've covered energy so closely for a decade and you know that traders in the pits love to hop on news and bid the price up. I was talking to Fadel Gheit (managing director and senior analyst covering the oil & gas) at Oppenheimer & Co. and he thought that $175 was ridiculous and it would only have a temporary impact because we would open it back up.”
Conversely, events could conspire to dramatically reduce prices. The Chinese economy, one of the linchpins for the demand argument behind current prices, also seems to be slowing with speculation that a variety of stimulus related bubbles in the country are about to pop. Such a development could certainly shock crude futures (and correspondingly in short order refined product prices) in the downward direction.
Also, Brent vs. WTI is primarily influencing current prices. Brent, being fairly Euro-centric, is positively influenced by the perception that European nations are making positive moves to get their economic crisis in order. Should that perception change, Milne noted that Brent could drop hard and that the geopolitical risk will have a more immediate impact on Brent prices versus WTI prices because of the location.
Richard Larkin, the president of Manchester N.H.-based Hedge Solutions, Inc. raised the following consideration. “On the crude side I think is we are going to be hanging out in this range of as low as $85 to $100 but, knock on wood, I do not see a lot of predictions for crude oil to hover above $100 a barrel over the next two quarters anyways,” he said. “You always have the geopolitical wildcard. What will be interesting between now and the election – I think you have the White House with its finger on the Strategic Petroleum Reserve trigger and I think they will use that politically to keep prices down.”
Moving into refined products, the EIA expects that on-highway diesel fuel retail prices to have averaged $3.96 per gallon in 2012 and to average $3.73 per gallon in 2013. Heating oil is expected to average $3.71per gallon this heating season.
“We are in a preseason rally where we have (recently) had some five-month highs. We will take that high out, I'm fairly confident, with the new high,” said Milne. While demand has been weak and last winter was exceptionally mild, there are factors propping up prices this season. “Supplies are low,” he said. “We've had some pretty good production, but if you look at the inventory levels were way below a year ago and well below the five-year average. That tells me that if we have a cold winter it will push prices higher, and if we see some renewed life in the economy, freight movements will increase and diesel demand will go higher and that provides the possibility for a significant jump.” Milne noted that diesel exports have been and will likely continue to be another supportive factor.
Philip J. Baratz, president of Ft. Lauderdale, Fla.–based Angus Energy noted that overall, the speculative relationship with current prices is still a driver. “On the one hand, you have an incredible amount of problems and tensions in the Middle East, but there is plenty of oil out there, and on many levels, oil has no business being well over $3 per gallon on wholesale especially with the weak economy,” he said. “The bullish side, which is bad news for the heating oil dealer, is that maybe the economy is getting better, but we just don't realize it yet. The reason I say it that way is that if you look at the equity markets, the stock market is the highest it's been since late 2007, and if it's growing faster than earnings, that must be in anticipation of growing earnings. Either the economy is going to get a lot better really soon, or if the economy is stagnant, then the equity markets have no reason being where they are. There is no free lunch. Speculating is fine as long as you recognize that you're speculating.”
Larkin sees a number of more localized challenges in the heating oil market. The impact of New York’s mandating ultra low sulfur fuel represents a 25 percent impact on the market that has to now be worked through the supply infrastructure. Also potentially impacting localized prices are Central and South American distillate exports. “A lot of the locations are going to be tight, meaning the differential between what they see at the NYMEX and what they are actually paying the rack has blowout potential,” he said. “The reason for that is that you are already going into the season low on inventory and then you look at where they are selling distillates in South and Central America, and there is a big (profit) incentive frankly to just not send those barrels up the pipeline to New York Harbor, which means you're not going to get consistent pipeline shipments. And if it's cold, you're going to have spot issues. The NYMEX price could be $2.75, but the oil price at the rack could be $3 or even $3.25.”
Natural gas is both a competitive fuel for the industry and a complementary product from some marketers in deregulated states. The EIA predicts the Henry Hub natural gas price will average $2.65 per MMBtu in 2012, with prices remaining below $3.00 per MMBtu until December. It further expects 2013 prices will average $3.34 per MMBtu.
“The mild winter really hammered natural gas and we put in that low in April with $1.902. It still is an overall bearish year and a contango market, but it seems a lot or drilling rigs are being moved to find more oil or there is less drilling and you had a lot of natural gas burned in the summer. So prices are going to be moving higher, but they should be in the $3 area again as we get into the fourth quarter. I don't think we would get into the $4 area unless you get a really cold winter and see (issues) with storage capacity.”
Baratz has a similar outlook in this season, but with some longer-term observations. “Prices have come way down because of all the availability of supply and because the economy weakened, but we’re now at a point where people have had to cut back on production,” he said. “So on the one hand I don't see it revisiting the $2 level anytime soon and certainly not this winter. The negative is that there is plenty of supply around there and the market has already shown that they are happy to produce at the $3 level and that makes you nervous. So the notion of an economy being so strong that prices will go up to $5 or $6 – I just do not see that happening any time soon.”
Many in the industry sell or compete with propane. Prices have been low and are likely to remain low in the heating season.
“You have a big surplus of propane and a big export demand,” said Milne. “This is directly due to the tight oil and natural gas finds—propane comes from both—so there's a surplus of production. Demand has been increasing so the lower prices should maintain some level of exports overall it's bearish short-term. One of the things we frequently see in the fall is propane used to dry crops and that definitely would not be happening this year. So if you look at prices in Conway (Kansas), they are affected greatly by the agricultural center and that is going to be weak. If you take away export demand, you're going to have a really hard time seeing any sort of push higher. If the petrochemical industries starts the pickup, and I think there's some talk that it's going to be happening with some new plants being built long-term, that will be very supportive of propane.”
This industry can live well or die brutally based upon the weather. Last winter was more in-line with the brutal death scenario. What does this winter hold in store?
According to Accuweather expert senior meteorologist Jack Boston this winter will almost certainly be better for the bottom line. “If you're looking for a comparison from last winter to this winter, I can tell you with 90 percent confidence that it is not going to be as warm as it was last winter. I can tell you another thing. The La Niña versus El Niño trend has definitely been following our forecast ever since last winter where we predicted that the La Niña would weaken to a neutral state by the early part of the summer and that it would become a weak El Niño, which it has.”
The result will likely be increased participation and lower temperatures across the southern part of the United States including California. While the East Coast will probably not going to get huge snowfalls, it should be above normal compared to last year.
“Another thing that happens is that unlike last winter we can get very cold Arctic air that comes in and sticks around for a few days and then it's gone,” said Boston. “It's not the type of thing that would put parts of the country in a deep freeze for a couple of weeks. The other thing that is going to greatly affect the winter is how much blocking we have in the North Atlantic. The North Atlantic oscillation is a major index that tells you if the NAO is a negative value the flow across the North Atlantic Ocean is blocked so what that does is forces more cold air masses down into the eastern United States. Last winter, to give you a comparison, the NAO was positive almost all winter. I would be very confident that there would be considerably more heating degree days this winter than last winter.”
He noted that while the confidence level was lower in the Northwest, that region would probably receive an average amount of precipitation and likely above normal temperatures.
“From the range of sources it appears we’re going to have a near-normal degree day pattern, and if we had normal winter temperatures, I believe that will be enough to tighten up supply a little bit,” said Larkin. “So we like locking in some basis with the supplier ahead of time to cover yourself in the latter months in case there is a problem.”
While the winter temperatures will certainly impact volume, the traditional impact on product price is not as solid as it once was according to Larkin. ”The heating component of the distillate pool has shrunk so considerably and the latest move by New York State only adds to it,” he said. “If you had the type of winter we had last year six years ago that would've tumbled prices in a major way. Last year in spite of it being one of the warmest winters, the prices went up instead of going down. That is because heating oil is representative and the whole distillate pool is such a small number now that it doesn't really impact the movement of price. If it's warm, it doesn't mean the price will necessarily come down and vice versa. For us in the hedging world it definitely changes the game.”