Heating Season Fuels Outlook— 2015/2016

By Keith Reid

Last winter was not bad for the industry. The prices were low for a change and the weather turned cold as the winter matured. The indications are that 2015 could provide more of the same.

Fuel Oil News interviewed experts for their perspective on what to expect in the coming months. We were assisted by Alan Levine and Brian Milne.

Levine is the CEO and chairman of Powershouse<r>, a group of seasoned energy experts and broker professionals working in partnership to meet the business goals of its customers. He is an internationally recognized expert in pricing and business practices in the energy industry. A petroleum specialist for over 40 years, Levine is a highly regarded authority on the relationship of energy futures to cash petroleum markets.

Milne the editor of Schneider Electric’s MarketWire—a real-time market and news service focused on U.S. oil product markets and relevant news and analysis, and also the editor of OilSpot—a weekly newsletter on the oil markets.

As should be noted, none of the projections outlined here are set in stone and individual purchasing and hedging decision should use this as simply a starting point and not the ending point in the decision-making process.

Note: These interviews were conducted around September 1 and are invariably and unavoidably somewhat dated by the time they arrive in print.

Crude Oil

Crude is important to prices for the most obvious of reasons—it is the primary price component. The crude price war between OPEC and the emerging world of fracking production continues.

The U.S. Energy Information Administration, in its latest Short Term Energy Outlook (September 9) forecasts that Brent crude oil prices will average $54/b in 2015 and $59/b in 2016. West Texas Intermediate crude oil prices in 2015 and 2016 should average $5/b lower than the Brent price.

The Saudis have been suppressing prices and keeping production up in an attempt to both maintain market share and drive the fracking competitors out of business. The Saudi’s recently claimed victory in their efforts, while other voices in the United States see OPEC as being on life support, if not dead. Conventional oil has traditionally been cheaper to produce, but costs are rising in many of the established production areas and shipping costs add to the mix. Further, many of these governments are heavily to almost exclusively reliant on oil to fund their national budgets and such low oil prices represent an existential threat. The Saudi price war has been aggressive, but so has the response as the fracking industry becomes even more aggressive, and successful, at boosting efficiency.

“We’ve seen the first indications of our friends the Saudi’s crying uncle,” Levine said. “What I mean by that is: have the Saudi’s been successful in their strategy? I would have to say yes if their strategy was to [permanently] lower the price, which I’m sure wasn’t really what they had in mind. What you’re seeing now, generally speaking, are only small reductions in output in the United States.”

He noted that producers now have a lower breakeven price because of the growing efficiency of current shale production. “They only have to drill one hole and then a bunch of horizontal lines from that point, and it’s more like a manufacturing process,” Levine said. “You can turn the thing on and off and you’re not hostage to traditional things like well pressure, I don’t think the Saudi’s thought much about that. So I think when the prices get up to where they are now in the $40s or low $50s [dollars per barrel] a lot of folks are going to say it’s time to start the rigs. So, I don’t think the oil price is going to be anything like $100 per barrel again.”

And that is particularly unlikely in the short term.

“We have a ton of crude oil supply globally and domestically, and we’re seeing product supply inventory–especially distillates–climbing as well,” Milne said. “Domestically we have crude stocks 25% over a year ago we have distillate fuel supply 22% so these are bearish fundamentals.”

However, that does not mean that there will be no volatility, or that prices are not capable of going higher. There was a significant rally in prices in late August where prices shot up nearly 30%, with Brent topping out at above $54 per barrel. Prices have since dropped but remain in the mid-$40 range.

Milne noted that the market had likely oversold through the summer as supply ramped up, the likelihood of Iranian oil coming online increased and the Chinese economic disruption cast doubts on the demand side.

“The market oversold there is no question about that,” Milne said. “So when you see those selloffs, and some support held, the thinking was that you had fertile ground for a rally. And then you top it off with some good data on the economy along with a US GDP revision of 3.7 % from 2.3%–a big change–and the market just took off like a rocket.”

Milne foresees the possibility of WTI rallying up to the $50s and maybe even touching $60. “But having said that, the timing is extraordinarily difficult to figure out,” he said. “I don’t think the downside is done yet and you’re probably looking at another WTI visit back to the $30s. I don’t think you see prices recover meaningfully until later in 2016, maybe getting back in the $60s or touching $70s. But a lot of things have to go in a certain direction for that to happen.”

Levin predicted the rally shortly before it happened and got the word out. He also sees higher prices in the future, but also with also caveats.

“We just had this dramatic rally,” said Levine. “One of the characteristics of the energy field is that when prices turn, they really turn. I don’t think we’re done. I think that we will see some effort at consolidation and maybe a decrease, but we certainly anticipate that prices will continue to move higher. What we’re seeing so far is a matter of short covering, which means the amount contracts–open interest–are diminishing. I expect to see that start to kick up and when we do prices are going to move a little bit higher. But there does seem to be a top on it now, and that’s probably the biggest news.”

That news does come with a practical downside beyond strictly industry and fuel customer concerns. “When their [OPEC] national budgets get tight that leads to regional instability, and that cannot be good,” Levine said. “The bottom line is we will pay for regional instability one way or another, either through higher crude prices or greater human misery.”

Distillates

According to EIA, heating oil is currently trading (as this article is compiled) at approximately $1.6 per gallon. In its latest STEO EIA anticipates an average retail price of $2.65 in 2016. On-highway diesel is currently retailing at about $2.50 per gallon and EIA anticipates an average retail price of $2.77 in 2016.

Where refined products are concerned the story seems to be abundant supplies, and more where that came from.

“Inventory is 22% above a year ago, and with the ultralow sulfur standard for heating oil it’s really hard to separate that out from diesel, Milne said. “Diesel is now at the highest supply level since October 2011 and we are still going to build, so you should have ample supply that is going to buffer any sort of dramatic price increase. What’s going to happen is refiners have been really sucking down a lot of crude because we have restrictions on exports, so it’s going to go right into storage tanks unless you see production shut-ins. I think what’s going to happen is sometime in October, and timing is incredibly difficult, we could see crude inventory start building and that pressures the price [downward] even as the products starts drawing down.

He did note there might be an uptick during the fall refinery maintenance season.

The demand side is also playing a role by underperforming. Milne noted that diesel and heating oil have been a bit of a laggard in prices in the face of demand issues.

“Even though we had a big revision in the GDP number, overall GDP has been relatively weak,” Milne said. “If you look at the freight transportation service index it is just not growing.” Diesel in the US is still used primarily in commercial and industry settings.

While prices should rise somewhat, Levine noted that dealers and marketers shouldn’t be too concerned–or too complacent. “I think heating oil prices will go a little bit higher,” he said. “But, a lot of the competition that has gone to natural gas has been ameliorated. The price advantage held by gas, while still substantial, is not at the level where you’re going to see a tremendous amount of pressure on heating oil as long as the situation remains more or less the same. We’re also seeing in the current environment a lot of fixed-price business. Everybody’s arguing how much lower can it go? I might add this also has me a little nervous. I do think it’s somewhat safer to offer fixed-price, but if you do I insist you provide some degree of protection against it. And calls remain inexpensive, even today.”

Propane

For propane, the tale is much the same as other domestic fuels.

“Last week we were just shy of the all-time inventory record for the United States, which was set in September 1976.” Milne said. “Propane prices are so low we are talking $0.40/gal (wholesale) or less. We’re just swimming in propane and they are running out of locations to store it.”

He noted that uncertain variables include the status of the current crop drying season and an increase in exports as capacity to export continues to build out.

The infrastructure issues present a few years ago still exist, but they have largely been worked around to where they should not amplify a problem. “A couple of years ago was really a perfect storm, and you did have strong demand from the agriculture sector for crop drying and you had an early cold winter and it just never relented and meanwhile some export facilities came online,” said Milne. “They still are building out infrastructure, which is true everywhere. But I can’t imagine seeing a situation comparable to what we had a couple years ago. There is just so much propane around now, unless you lose of pipeline or suffer an industrial accident.”

Still, Levine urges some caution. “I wouldn’t get too complacent,” he said.

Natural Gas

Natural gas is also in familiar territory, and similar to the other fuels where supply and demand are concerned. “We’re looking at supply being more than 18% above year ago which is pretty bearish, and were even over the five-year average, so right now there is nearly 3.1 trillion cubic feet in storage,” said Milne. “So that’s plenty of supply and that’s going to keep on building. But until you get some serious cold it’s going to be difficult to see that number move higher, and in fact it traded at a four-month low earlier this week. That supply is going to drown out any sort of attempt at rallying prices outside of logistical issue, which can happen, but anything like that would be temporary.”

The latest STEO predicts average spot prices to remain lower than $3/MMBtu through November, and the Henry Hub natural gas price to average $2.84/MMBtu in 2015 and $3.11/MMBtu in 2016.

Gasoline

According to EIA, regular gasoline is retailing at about $2.40/gal. The latest STEO forecasts U.S. regular gasoline retail prices to average $2.38/gal in 2016.

“RBOB had some pretty good rallies this summer because a really strong demand and if you top that off with a couple of refinery outages, with refineries running nearly full-out  in some markets, you expected the market response,” said Milne. “Realistically gasoline demand is going to fall off, and we’ll see how resilient it will be for the rest of the year if consumers decide to drive more.”

Levine also supported that noting that gasoline demand should start to taper off “but with these prices, my God. I can’t fill my car for more than $37. It’s amazing,” he said.

Weather

About the only significant factor that stands to impact heating fuels prices this winter is the weather. Last year EIA forecasted a milder winter, and it generally was going out of the holiday season. Then the big freeze hit. This year, the weather buzz is a familiar one. No, it’s not polar vortex, but El Niño. That would suggest a milder winter in the key heating markets… but maybe not.

As The Weather Channel Meteorologist Dr. Doug Gillham noted in a September 14 forecast, milder weather is likely true for the fall and early winter, but 2016 may go into spring like the winter of 2015. He stated: Later in the season, especially during February, we expect several weeks of classic winter weather over the eastern third of the country.

He went on to add: As we look at the winter as a whole (December through February), we expect that the final numbers will show below average temperatures across much of the South, northward to the Mid-Atlantic States. In contrast, a rather mild winter is expected from the Pacific Northwest to the Northern Plains. Across the Great Lakes and Northeast, the mild start to winter will be offset by the colder conclusion to winter and result in temperatures that are close to normal.

The Farmers’ Almanac has many faithful followers despite it’s less-technical underpinnings (though that has certainly changed with the times). According to the Farmers’ Almanac: The winter of 2015–2016 is looking like a repeat of last winter, at least in terms of temperatures with unseasonably cold conditions over the Atlantic Seaboard, eastern portions of the Great Lakes, and the lower peninsula of Michigan, Ohio, Kentucky, most of the Tennessee and Mississippi Valley, as well as much of the Gulf Coast.

New Englanders will once again experience a very frigid (shivery) winter (Déjà vu).