For the fourth year running heating oil has continued its pattern of the high coming mid- winter. This year prices topped out in January. But by early February, all petroleum products slid into bearish territory and by late February it looked like a steep decline was in the offing. That move lower was preempted by Russia’s aggressive foreign policy in the Crimea and (much more importantly) the Ukraine. This halted the bearish move down in pricing. The reason the Ukrainian conflict is a driver in energy prices is that Russia exports about 30% of Western Europe’s natural gas and petroleum products via pipelines that cross the Ukraine so any disruption in supply out of Russia means Europe will be looking elsewhere (the US export market) for the lost supply.
photo by A.J. Marro Copyright 2009 Rutland Herald
From mid March to mid June oil traded sideways (neither bearish nor bullish) within a large but stable 20-cent range. Just as we were getting some sort of resolution (a moderate Ukrainian president) to the Russian situation, the unforeseen and shocking ISIS incursion into Iraq and their northern oil fields injected a 22-cent premium into product prices, breaking resistance to the upside and putting all Petroleum products into a technical bull market. With that in my mind, it appears that for the near term at least, prices will be edging higher.
WTI (West Texas Intermediate) crude is now trading at $105 per barrel and ICE Brent Crude (European Crude) is at $111 per barrel. The spread between the two benchmarks has now come into balance with the price of transportation. By that I mean it costs about $6 per barrel to ship WTI (American Crude) to European refineries. The fact that there is not a huge arbitrage window to export US crude and refined products to Europe leads to a more stable import export market. This is good news for heating oil dealers that have to manage inventories as it takes out one element of volatility in prices.
Heating oil is currently about 28 cents higher than this spring’s low. It is interesting to note that both this and last year’s low occurred in June. While it is too early to say for sure whether we have had the lows for the year, I think that with the instability in Iraq and Ukraine, regrettably, the lows are most likely in our rear-view mirror.
One interesting feature in the futures market is an extreme ‘backward dated’ market. In a normal environment, a futures market trades 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 going rate. A market in contango encourages storage for the simple reason that if I can buy and store the physical product cheaper today than what is available via futures contract I can increase my margin on fixed price offerings. In effect this gives an economic incentive to buy and store oil, leading, over time, to a well-supplied market and usually lower pricing. A backward dated market is the opposite. Futures contracts that trade flat or even below the spot price often lead to lean inventories and exposure to seasonal, demand driven price spikes. In fact in January we had just such a spike as extreme cold weather combined with a vicious spike in natural gas prices (natural gas prices briefly exceeded a price that was the equivalent of crude oil at $200 per barrel!) pushed heating oil up 60 cents above its 12-month low and 40 cents higher in about a week. The driver of this event was that there wasn’t enough natural gas to meet the simultaneous demand of heating and electricity generation so power companies bought ultra low sulfur diesel to run their generators until natural gas’s spike abated.
What makes this particular backward-dated market interesting is how far out it goes. With January 2015 futures contracts trading a mere five cents above spot prices, January 2016 ten cents below current spot and January 2017 a whopping twenty cents below, traders are expecting lower prices in the future. My consultant thinks two factors are at play in this phenomenon. First, US production is at all-time highs with ever-increasing levels including crude and natural gas production, and second, distillate consumption will flatten out or even decline as homes get more efficient and (even more importantly) commercial fleets continue to migrate toward natural gas for propulsion. The estimate is that the commercial fleet conversion rate will be about 7% per year over the next seven years. This could have a very bearish impact on distillate prices (heating oil, diesel and kerosene) since about 70% of all distillate is used for transportation.
What could cause oil to slip into a declining market? A quick defeat of ISIS in Iraq by government forces and some sort of long-term stabilization in the Ukraine would go a long way toward easing trader concerns. I am not holding my breath.
What could cause oil to rally up? A defeat of Iraqi government forces by ISIS, Russian aggression in the Ukraine, weakening of the US dollar, and of course the usual summer price bogey man, hurricane season.
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.