This past winter was virtually unprecedented for Rutland Fuel Company, as I am certain it was for other energy suppliers in the Northeast. Degree Days ran 30% colder than average, including a stretch of 16 consecutive days where temperatures fell below zero. The Hudson River froze over in mid-February leading to a 50 cent basis spike*, even as we had an historic drop in all petroleum prices including a whopping $1.50 for heating oil. Price volatility and extreme cold made for a particularly intense winter. Drivers worked longer and harder, equipment was pushed to the limit and the phones would not stop ringing. But spring is here and before we look forward, let’s take a look back.
photo by A.J. Marro Copyright 2009 Rutland Herald
Look at the above chart. This is the most volatile 12- month heating oil chart (excepting the ‘once in a century’ financial collapse of 2008-9) that I have ever seen. It should stand as a cautionary tale to all buyers and sellers of heating oil price guarantees. On June 5, 2014 the charts suggested a new bull market. Isis had seized oil refineries in Iraq while Russia was backing (some say fighting for) Russian separatists in the Ukraine and it looked like prices were poised to explode upward. Why then did we see a prolonged and prodigious pullback?
The first of three main factors that are most often cited is the strengthening of the US Dollar. The dollar versus euro chart below looks very similar to the heating oil chart above. As you can see there is currently a close inverse correlation between the strength of the dollar and what we pay for oil. If the dollar weakens versus the Euro, what we pay for oil in US dollars will rise. This past year as the dollar strengthened all petroleum products fell. The second major factor in falling prices is the US energy boom. US crude oil and natural gas production is at its highest output ever and crude inventories are at maximum levels. And even though this past year’s price decline has caused a decrease in ‘new rig counts’, US production remains strong. The third factor that accelerated the drop in prices was Saudi Arabia going against the will of the other nation members of OPEC and choosing not to cut back on production.
OPEC announced this policy the day after Thanksgiving (look at the above chart for confirmation). Prices fell off sharply, breaking several key barriers of support (including the “magical” $70/barrel. This was a level I had heard so much about over the past 5 years, with most analysts thinking that if oil dropped below $70-65 per barrel level US production (which has 2 to 3 times the production cost that Saudi Arabia has) would drop off the table. This hasn’t happened and if oil rallies back above $70 per barrel, it won’t. Again, new rig counts in the US are down but production isn’t.
Going forward it appears as if the Euro has finally stopped its slide against the US dollar and Oil has made a bottom and in fact may be in the early stages of a reversal that could see it head back to $80 to $90 per barrel. But weighing against a move up is the fact that crude supplies are still surging both domestically and abroad. Volatility is still the watchword. Most of the analysis I am reading projects WTI Crude Oil to spend the next 12 months or so between the $60 and $70 range. Keep in mind analysis from anyone should always be taken with a grain of salt as virtually no one I follow foresaw last year’s giant price slide.
For the first time in 18 months or so the futures market is no longer “backward dated.” Backward dated means that futures contracts trade flat or even below the spot price. This often leads to lean inventories and exposure to seasonal, demand-driven price spikes. In fact in February we had just such a spike as lean inventories and extreme cold weather choked off Albany supply up the Hudson River. That, combined with a vicious spike in natural gas, pushed heating oil up about 45 cents higher in about a week. Luckily for customers who didn’t lock in last summer, it was on the back of a $1.50 drop in prices from a year ago.
Now the market is “in contango.” When a market is in contango, a futures contract trades to a premium of spot price. This is logical. A guaranteed price in the future should be more expensive (think fixed mortgage versus adjustable) than the daily fluctuating spot rate. A market in contango encourages storage for the simple reason that one can buy and store the physical product cheaper today than what is available via futures contracts. In effect this gives an economic incentive to buy and store oil, leading, over time, to a well-supplied market and usually lower pricing.
So going forward we have two contradictory price indicators. One for prices falling: a very (historically even) well supplied Crude oil market. One for prices rising: the US dollar looks like it has found a top with regards to the Euro and the trading charts for both the Euro and for crude oil have flipped into bullish (slight bullish, but definitely bullish) territory. Which will win out? No one knows for sure but most analysis (as I noted above) seems to think that the two will battle it out and oil will get locked in a range of $60-$70 per barrel. Trading is expected to be volatile in that range. This roughly translates into a 30-50 cent range on refined products.
* Basis Spike: In the heating oil industry the ‘Basis’ means the price difference between the point of entry (in our case the NY Harbor) and a supply terminal ‘upstream’. Albany is where we get most, but not all, of our product. Typically the ‘basis’ from NY Harbor to Albany is 9 to 13 cents per gallon. Late this winter the basis spiked up from 10 cents to 50 cents. Usually a basis spike means there is not enough supply to meet demand.
-Scott Sullivan, May 21, 2015
The Rutland Fuel Company has a variety of programs
available for those who wish to approach the coming heating season with
a strategy. We would be happy to discuss these programs with you
personally. Call us at (802)773-7400 or stop by our office for a chat.
Why Choose Rutland Fuel:
If you are a consumer who prepays to lock in with a fuel dealer you should be very concerned with how your company hedges their fixed-price programs. The volatility of the price can blindside dealers that don’t hedge properly in a way that cannot be understated. In the past few years Rutland has seen two of its most prominent oil dealers get forced out of business due to oil price volatility. One dealer bought too much fixed-price oil and when oil dropped he was stuck selling oil nearly 2 dollars cheaper than what he paid for it. The other one (18 months later) apparently sold more fixed-price oil than he purchased and when oil rose, he was buying it for more than what his guaranteed rates were.
In times like these it is important you choose a fuel supplier you can trust. As oil has whipsawed up and down during the past five years, we have remained on a solid financial footing because I run these programs the right way: I lock into oil only for the customers who lock in with me. We don't speculate, rather we hedge our programs as diligently as possible. For fixed-price plans we purchase heating oil futures contracts and for CAP plans we purchase futures contracts with "put" option protection. I think what sets us apart is that we offer our fixed and CAP programs over a much longer period than most other oil dealers. The truth is that no one really knows where oil prices are going next, so I don't want my customers to have only a six-week window in the summer to set their price for the coming year. Instead, prepay customers can lock into some as early as springtime, and price out the rest later (during summer/into the fall) to average in their cost. For those who prefer to jump in all at once, they have a period of many months to decide when the time is right for them. And we offer discount programs for those who do not wish to lock in a fixed price for the winter season. We strive to maintain flexibility in our offers while protecting those who lock in, by covering their needs almost simultaneously when they lock in.