Oil Prices into Heating Season

The leaves are changing and there is a chill in the air. As summer comes to an end, heating season gets ramped up. Unfortunately, oil prices remain ramped up as well. Fuel Oil News asked around a little to see what can be expected with oil prices this winter and what to expect from old man winter himself. The good news is that prices should not go much higher (unless they do, but probably won’t). The bad news is that prices should not go much lower (unless they do, but probably won’t).

FON interviewed Brian Milne, DTN Refined Fuels Editor and Peter Beutel, president and chief editor of Cameron Hanover, Energy Risk Management Services for their perspectives on oil prices this winter. In general, they expect prices to stay fairly close to $3 per gallon with perhaps a dime leeway in either direction. Neither expects a serious drop or run up in price, though Milne sees either possibility with the right set of factors.

‘Right now we have some pretty strong resistance around $3.10 and that will likely hold for a while,” said Milne. ‘And I would say we will likely move back down below three dollars into the $2.90 or $2.80 area, but I do not think it will last that long because we are going to be moving into the heating season.”

Milne noted there is ample supply, but also a slight uptick in diesel demand correlated with GDP. ‘If you add that (increased demand) to the heating season, you are likely looking at an upward movement through the fourth quarter of 2011 and into the first quarter of 2012 and at that point the weather will come into play,” he said. ‘And if we have a moderate winter we could see prices peak in January and then start declining.”

Beutel generally agrees. ‘At this point I don’t see any real reason for heating oil prices to get a lot stronger unless something amazingly bad happens or something amazingly good like the recovery of the economy,” he said. ‘There a lot of reasons for them to get weaker, but they don’t. The market never seems to be able to drop more than 10 cents at a clip. There are plenty of days when I think it should drop 20 or 30 or 40 or 50 cents, but any time it drops 20 cents it rallies at least 10 cents back right away. At this point I don’t think prices are going to be much different. I think they’re going to slowly move lower into March.”

Although this article goes to press before the U.S. Energy Information Administration has began its heating season updates and outlooks focused on heating oil and propane, the EIA expects that on-highway diesel fuel retail prices, which averaged $2.99 per gallon in 2010, will average $3.85 per gallon in 2011 and $3.87 per gallon in 2012.  Projected U.S. refinery diesel fuel margins increase from an average of $0.38 per gallon in 2010 to $0.65 per gallon in 2011, then fall to an average of $0.58 per gallon in 2012.

FON will provide a synopsis of the formal EIA heating season updates when they are released.

In some better news for oil and propane dealers, the EIA’s latest Short Term Outlook noted that the Henry Hub spot price for natural gas averaged $4.05 per MMBtu in August 2011, which was 37 cents lower than the July 2011 average. The outlook lowers the 2011 forecast by 4 cents to $4.20 per MMBtu and lowers the 2012 forecast by 11 cents to $4.30 per MMBtu.  The increase in price from 2011 to 2012 reflects some tightening in supply as production growth slows in 2012.

Could prices collapse or spike?

There is a lot going on in the world that could trigger higher or lower prices whether you believe either fundamentals or hyperinvestors/speculators are driving prices. Could there be a repeat of what happened in 2007-2008, either upward or downward, during this period?

‘We already seeing gross domestic product downgrades and there’s ongoing fear of the U.S. slipping back into recession, and you really saw that heightened at the end of July when the Bureau of Economic Analysis that looks at GDP figures came out with a report that saw major downward revision of first-quarter U.S. GDP from 1.9% to 0.4%,” said Milne. ‘That was huge and raises the possibility of recession. And if we go into recession this market is going to come off hard and will definitely be well below $3 and potentially down to the low $2 level ‘ say $2.28. And depending on how bad it gets, it could go even lower than that.”
The EIA significantly dropped its economic outlook in September from its October report, to assume that U.S. real gross domestic product grows by 1.5 percent this year and 1.9 percent next year compared with 2.4 percent and 2.6 percent, respectively, in the previous Outlook.  World oil-consumption-weighted real GDP grows by 3.1 percent and 3.8 percent in 2011 and 2012, respectively, compared with 3.4 percent and 4.1 percent in the last Outlook.

However, Milne noted that the disconnect between WTI and Brent contracts, the economic uncertainty in Europe, domestic exports, OPEC reducing production to put a floor on prices and the slow recovery of Libyan production will all work against any sustained drop in prices.

On the upward side, Milne noted that if the Fed policy (despite weakening the dollar) and any pro growth initiatives out of Washington avert a recession and provide for stronger growth demand will similarly grow and drive a market reaction. ‘If the economy is able to start pushing itself up again, then you are talking about fuel demand starting to grow and that is important. So if we work on that premise that we should see the contract move higher. Earlier this year, around April, we had a $3.33 high and that is been the highest since the summer of 2008 so that was a big deal. And depending on how everything moves forward, we could challenge that number during the winter season.”

Beutel feels that it is unlikely that we will experience either the significant run up or collapse in prices that marked 2008. ‘It seems as if we’ve reached a stasis point between $2.80 and $3.10 ‘ somewhere in between there for heating oil,” he said. ‘We may see those numbers gradually slipped lower by nickel here or a dime there. So if we had this conversation in a couple of months we may be talking about something between $2.70 and $3. I think the numbers are gradually dropping but not anything very fast or far.

‘The amazing thing about this market is that there is something that seems to keep the price resilient all of the time. I keep telling my fuel oil distributors not to buy it here, but what seems to happen as we go down three cents then rally two-and-a-half cents. Drop four cents rally three-and-a-half cents and it doesn’t seem that we’re that much different when I turnaround next time. We dropped down to $2.80 then were back to $2.90 then were back above $3’how did that happen? This is an amazingly resilient market for reasons that escape most of us that were brought up on supply and demand. You don’t know on any given day if you are looking at a market that is going to, on that one day, look at the fundamentals or whether we’re looking at stock markets that day or the dollar or something someone says on Saudi Arabia or the weather or Tripoli’it could be anything.”

Wither the weather

From a weather perspective, the anticipated winter in key heating markets in the Northeast, Mid-Atlantic and Northwest also promise nothing extreme on either end. FON contacted State College, Penn.-based AccuWeather for an early season forecast. Predicting the weather is about like predicting oil prices these days, but although it is preliminary, AccuWeather’s senior meteorologist and head of the long-range department, Paul Pastelok, noted that there are some strong indicators about what might be expected during the coming winter.

‘Our official winter forecast doesn’t come out for another couple of weeks, but we already have some general ideas of what to expect going into the winter season,” said Pastelok. ‘We usually don’t try to plot things this far out, but this year is very similar to some years in the past with the type of tropical summer season that we’ve had and the potential to go back into a weak or moderate La Niña. So we are comfortable making a few assumptions.”

Pastelok stated that the Northeast should have a milder winter compared to last year from the standpoint of precipitation, which does have an impact on temperatures. As far as the cold goes, the more extreme temperatures are going to be shifted a bit farther to the west mainly from the Appalachia’s back into the Midwest and West. ‘The Northeast should have a cold beginning of the season from the Thanksgiving time period into December or early January, but then there may be a turnaround where it’s not as cold. We could see above normal (but still, of course, requiring heating) temperatures toward late January or February. We are working on that to see if the turnaround is going to be right, but we’ve seen several years that relate to what we’ve seen this year where that has happened. You’re still going to be heating, but maybe not at the same rate that we saw last year.”

Pastelok noted that in the Midwest and Plains states things could potentially be considerably cooler by 8 to 9 degrees on average over extended periods of time. The warmer Great Lakes weather will mitigate the impact of cold air moving eastwards, but as those temperatures equalized during the year all bets will be off. ‘Those in the Southeast may have milder weather than last year and some of that mild weather may get pushed North on occasion,” he said.

The winter should also be milder in the Northwest compared to last year, but then last year was fairly exceptional. Pastelok sees a milder start to the winter season in the more coastal areas, at least through December, perhaps with more precipitation. But, that should change. ‘As you get into February or March all of the cold that was aimed for the first part of the winter season on the Northern Plains could shift farther west with the brunt of it going into the areas of no man’s land like Montana and Wyoming and up towards the Cascades. Areas like Spokane down to Boise could get into some cold air as you get into the second half of the heating season. For coastal Seattle and Portland ‘ you may have your chill spots once in a while, but I don’t see anything extreme at this point.”

In the Canadian Northwest, Pastelok noted the farther north you go, it’s probably going to be dryer and cold so you might see the above average use of heating in the mid-to-late season.