With the onset of heating season, one thing is certain: there is plenty of supply – so much that it is expected to have a continuing effect on how demand and price interact during the coming cold months, according to experts and observers at market information services and at the Energy Information Administration (EIA), the statistical arm of the U.S. Department of Energy.
“We’re hovering around 25-year highs in inventory right now,” Brian Milne, renewable fuels editor for Telvent DTN, said in September. Telvent DTN provides news and market information on refined fuels, commodities and futures trading. “We’re heading into the winter season with a huge surplus in distillate fuel oil including diesel and heating oil.”
The much reduced economic activity of “the Great Recession” as it has been labeled by many, saw demand plunge and remain slack, resulting in the current abundance of supply.
“In 2008 we had lower global oil demand than we did in 2007 and this year the [EIA] projections are that we’re going to have lower global oil demand against last year,” Milne said. “The last time that happened was in the early 1980s. It’s a very bearish phenomenon and it was the direct result of the recession, not just in the U.S., but globally. Demand was cut dramatically.”
A survey by Platts, the division of The McGraw-Hill Companies that provides information on global energy markets, shows there is going to be more crude being produced, said Robert Sharp, renewable fuels editor. Further, the Organization of Petroleum Exporting Countries (OPEC) is weighing an increase in production, Sharp said. Meanwhile, he said, “Demand still isn’t picking up.”
These factors resulted in heating oil prices this fall that are the lowest in some time. The American Institute for Economic Research, using data from the U.S. Department of Energy, reported that, factoring for inflation, heating oil prices in September were at their lowest point in four years. The Independent Connecticut Petroleum Association (ICPA), a trade group that represents independent oil dealers in the state, reported that heating oil prices in September were down 50 percent from a year earlier and hailed the shift as a boon to consumers.
The following is a more detailed look at what is being said about the current supply situation, including a discussion of the effect demand could have on the surplus over the coming season, and what the implications might be for heating oil prices.
Just how big is the current supply of heating oil? The nation’s stock of distillate greater than 500 ppm sulfur was at 49.3 million barrels on Sept. 11; one year before, the inventory was a considerably lower 35.7 million barrels, according to EIA statistics. That’s a difference of 13.6 million barrels.
The bulk of that total U.S. inventory of heating oil is in the East Coast: 40.3 million barrels. Contrast that with the East Coast inventory a year ago, when it was 26.9 million barrels, according to the EIA’s figures.
The bigger picture is that distillate inventory levels, which include No. 2 oil, generally are exceptionally high not only in the U.S., but in Europe and Asia, “and there are some quantities we don’t know about because they’re being held in tankers off-shore,” said Milne of Telvent DTN. The move to store product in vessels began early this year, according to Milne, when the market “flipped into contango” (distant delivery prices for futures exceeded spot prices).
“Ships, if they weren’t moving around, were being converted into floating storage vessels” by companies and large brokers, Milne said. The heating oil market on the New York Mercantile Exchange was in contango at the beginning of this year, Milne said, though since then it has been easing “so we’re not seeing that type of an action” – movement to floating storage – “now, but still the result is we have a huge overhang of supply.”
Lately, there have been reports and declarations that the Great Recession is over, or at least subsiding, and that there are signs, however modest, of economic rejuvenation. Whether this will translate into an uptick in futures prices and/or demand remains to be seen.
Milne noted that the government’s economic stimulus package, and upward movement of the stock market had nurtured “sentiment that the recovery in the economy was coming.”
Along with expectations of an improving economy, Milne observed, “the anticipation is that demand for crude oil and its products will be higher. The caveat here is with heating oil. Because there’s such a large overhang, it’s going to limit how far heating oil [prices] will increase.”
According to the latest Short-Term Energy Outlook published by the EIA, a “modest economic recovery projected for 2010” is expected to contribute to a 260,000‐bbl/d (1.4 percent) increase in total liquid fuels consumption, led by an increase of 110,000 bbl/d (2.9 percent) in distillate consumption.
Milne talked to National Petroleum News in September. During the phone interview, he checked the per gallon price on heating oil futures on the New York Mercantile Exchange. It was at a $1.78.
“That’s right now,” Milne said. “There’s upside resistance at around $2.12 – right around that area.” The week before, the futures price had been at a low of $1.70.
“We could see this go again below $1.70, towards $1.65 area,” he said, “if demand really isn’t coming back as much as we thought, or if China is buying less supply or if the economy lurches backwards a little bit. It’s going to depend very much on what crude oil does.”
And then of course there is always the weather.
“If we have a very cold winter, that’ll help out,” Milne said. “If we just have a mild winter, that’ll be very bearish considering the amount of supplies we have.”
A normal winter is unlikely to affect futures prices one way or the other because of the abundance of supply, Milne said.
“One other thing I would add is that we need to watch the U.S. dollar,” he said. When the dollar weakens, he noted, “that helps push up commodities prices.”
Biodiesel Production is Down
“It’s been a pretty bad year for biodiesel producers,” said Brian Milne, renewable fuels editor of Telvent DTN. “The biodiesel price is way above the diesel price and diesel demand is down.”
The Renewable Fuels Standard (RFS) was to have required that 500 million gallons of biodiesel (B100) displace petroleum-based product in 2009, Milne said.
But last November, the Environmental Protection Agency, which administers the RFS and is charged with ensuring compliance with it, announced it didn’t have a mechanism to measure compliance, Milne said. “So they delayed it.”
Consequently, demand for 500 million gallons this year was pushed back to next year, Milne said.
That’s not all.
“On top of that, diesel demand is getting crushed as a result of the recession,” Milne said. The feedstock for the bulk of U.S.-produced biodiesel is soy, and the cost of soy has increased. So much so, said Milne and Robert Sharp, a renewable fuels editor with Platts, that the benefit of the dollar per gallon tax credit that producers get for blending biodiesel with petroleum diesel is often negated.
“Biodiesel is not profitable to make, it’s not profitable to use—even with a dollar-a-gallon credit,” Sharp said. To make soy-based biodiesel costs somewhere around $1.90 to two dollars per gallon, with the tax break included, according to Sharp.
The U.S. biodiesel industry also took a hit from the European Union.
According to Milne, biodiesel producers in U.S. were getting the U.S. blenders’ credit and then shipping product to Europe, where it qualified for still more incentives. The European Union took exception and reacted last spring by imposing a tariff on U.S.-produced biodiesel.
That took away the biggest demand market for U.S. producers; they made nearly 700 million gallons of biodiesel last year and sent most of it to Europe, Milne said.
Also, a blenders’ credit for biodiesel made from less expensive fatty acid methyl esters (FAME) was increased by Congress last year, making it equivalent to the credit for soy-based biodiesel, Milne said, “and as a result the FAME biodiesel could be produced at a lower cost than the soy-based biodiesel.”
“It was really a kind of punch below the belt for the biodiesel industry,” Milne said of the combined effects of all these developments.
Bankruptcies abounded in the biodiesel industry this year, Milne said.
“The biodiesel industry is saying about 70 percent of production capacity is shut in the U.S. as a result of bad economics,” Milne said. “When I talk to people, they say it’s more like 80 to 85 percent of the industry that’s shut right now.”
Some states or regions, including Oregon, Washington State and the Great Lakes area, have mandates for biodiesel, Milne said. “So there are some pockets of demand.”
But U.S. biodiesel production is going to be on a far smaller scale than the nearly 700 million gallons of last year, according to Milne. “It’s going to be less than half of that this year,” he said.