A HEAT USA member recently contacted us with a great question: “I have always wondered why the price of heating [oil] is more than regular gasoline, when there are no taxes on it.” Actually, it is more of a statement, but still an interesting subject to wonder about.

It is logical to think that, since they are both refined from crude oil, that heating and gasoline should have similar prices per gallon. Add the state and federal taxes on gasoline, and you can expect gasoline to consistently cost more than heating oil, which is not taxed. Although this is sometimes the case, it is certainly not always the case. A quick look at the Energy Information Administration’s short-term energy outlook shows that on average, gasoline prices were in fact slightly higher than heating oil prices in 2006 and 2007. However, 2008 price averages and 2009 projected averages both show heating oil as slightly more expensive than gasoline.

So what accounts for these shifting price differences? First, we should note that gasoline and heating oil prices vary quite a bit in different areas of the country. A resident of New England might be paying $2.70 per gallon for gasoline and $2.95 per gallon for heating oil while a resident of Southern California might pay $3.05 per gallon of gasoline and $2.80 per gallon of heating oil. The point is, the most influential factor that determines how much you pay for gas and heating oil is where you live.

As for prices in the Northeast region right now, it seems that heating oil is more expensive than gasoline in most areas. There are two basic explanations for the current situation:

Supply and demand. Over the last few months, government statistics have repeatedly shown a steep drop-off in American demand for gasoline. Because of the tough economic times, Americans are driving less and therefore using less gasoline. Because demand for gasoline is historically low, oil companies are forced to lower retail prices to make sure they are still attracting customers. On the flip side, temperatures are dropping throughout the Northeast and winter is coming soon, so people are using more heating oil than they did three or six months ago. Higher demand for heating oil means that oil companies (both wholesalers and retailers) can raise their prices and still keep customers. In the summer of 2009, when Americans will be driving more and heating less, prices will most likely shift in the opposite direction.

Vertical consolidation. In the case of gasoline, most oil companies have what I call “pump-to-pump” control of the product. A huge multinational corporation like Shell owns the oil pump that extracts crude from the ground in Nigeria or the Middle East, owns the refinery that makes gasoline from the crude, and owns the pump that you use to put unleaded gas in your car. One company controlling the product through the entire production and retail process means the retail price is insulated from outside influences mainly profits taken by middlemen. Shell may be currently selling gasoline at a break-even price or even take some losses in order to keep sales up. When gasoline demand increases again (which it almost certainly will–the only question is when), Shell can then raise prices and recover most or all of the losses they incurred during the current low-demand period.

The extraction, buying and selling, and market trading of crude oil and its products like gasoline and heating oil are all incredibly complex processes. Although the simple explanations offered above to provide some insight as to how and why prices change, they cannot completely explain, much less predict, oil price trends.

After continuing yesterday’s steady rise in interday trading, the price for a barrel of crude continued to increase overnight, peaking near $60. Official confirmation that the European Union has entered a recession seemed to spook oil investors early this morning, bringing crude prices down to just over $57 a barrel.

Data that OPEC member nations are in fact complying with an agreement to cut overall production by 1.5 million barrels a day and bargain-hunting may have contributed to a cautious recovery around 8:00 am this morning, putting crude near $59 a barrel. Heating oil was at $1.88 per gallon as of 8:42 am, a fraction above its opening price.

HEAT USA price experts confirmed a small up tick in retail heating oil prices this morning, and predicted a short decline in tomorrow’s prices after a flat trading day today.

HEAT USA Price Report
Today’s average heating oil price per gallon: UP $0.04
Morning Projection (for Monday’s average price per gallon): DOWN $0.01

The Dow Jones Industrial Average rose over 500 points today, helping to pull up crude and heating oil prices, which rose 5% and 3%, respectively.  An EIA report released today showed that “demand destruction is still occurring,” said Tradition Energy analyst Gene McGillian, quoted on CNBC.com.  But a lower-than-expected increase in US crude inventories and the announcement of plans for another OPEC meeting on November 29th stimulated enough confidence to bring about an up day for crude and heating oil.

HEAT USA price experts noted another day of steep ups and downs for oil prices, and expected a small increase in retail prices tomorrow.

HEAT USA Price Report
Evening projection (for Friday’s average heating oil price per gallon): UP $0.04

Crude and heating oil prices inched up this morning, both increasing by less than 1% at 9:35 am eastern time following crude’s 22-month low of less than $55 a barrel yesterday.  From CNBC.com: “‘The only thing supporting the market is the possibility of OPEC cuts at the end of the month, but the production cuts would probably only be in step with falls in demand,’ said Christopher Bellew of Bache Financial.

HEAT USA price experts confirmed a big drop in retail heating oil prices this morning to match yesterday’s market plunge.  They predicted small increases in tomorrow’s prices.

HEAT USA Price Report
Today’s average heating oil price per gallon: DOWN $0.09 to $0.10
Morning projection (for Friday’s average price per gallon): UP $0.02

After-hours trading drove the price for a barrel of crude down to $55.64, after it settled at $56.16 at the market’s close.  The price for a gallon of heating oil also dropped sharply, losing over 5% on the day and settling at $1.83.  Reduced predictions of oil consumption by the US EIA and IEA further intensified fears of a major worldwide recession.

“Fear global recession is worsening day by day is driving this market down.  Demand for oil is deteriorating week by week,” said Rob Laughlin, senior oil analyst at MF Global, quoted on CNBC.com.

HEAT USA price experts were pleased to announce a hefty drop in retail prices for tomorrow.

HEAT USA Price Report
Evening projection (for Thursday’s average retail price per gallon): DOWN $0.10

New York State from space Image: WorldMapsOnline.com

New York Attorney General Andrew Cuomo’s office issued a press release yesterday to announce the creation of the Oil Efficiency Pilot Program.  The program will provide financial assistance to needy families in New York State to help upgrade old heating systems and increase home energy efficiency.  The program will receive $1.9 million in funding as part of a $75 million settlement that Cuomo secured last year from American Electric Power, the nation’s largest energy company.  The company was fined for its coal-fueled power plants that were operating in violation of the federal Clean Air Act.

The pilot program, as part of the comprehensive HeatSmart NY program, is expected to extend assistance to 500 of the neediest 3 million New York families who rely on oil for heat.  The Attorney General’s Office also touted the program’s environmental benefits, saying it will help to reduce greenhouse gas and other polluting emissions.

New York residents who are interested the program should call 1-877-NYSMART.

At HEAT USA, a common question we receive from members and non-members alike is, “What’s the price of heating oil today?” As we always explain, the price of heating oil depends where you live, who your supplier is, whether or not you are a member of HEAT, and many other big-picture factors. What are those factors, and how do they lead to higher or lower retail prices for heating oil? It is a simple question with a complicated answer. We at HEAT This Week try to provide simple and straightforward explanations for why the price for a gallon of heating oil changes so rapidly. We have compiled a list of three factors that influence the price of heating oil in an attempt to help consumers understand how they could pay $2.90 a gallon one day and $3.10 the next.

Crude Oil. Also known as petroleum, crude oil is the main ingredient in heating oil (also know as number 2 fuel oil), as well as kerosene, jet fuel, and gasoline. Petroleum is also used to manufacture other essential materials, including lubricating oils, plastics, and asphalt. With so many uses, it’s no wonder that crude oil is the fuel of the world economy. Add the fact that crude oil is increasingly difficult to get out of the ground to consistently high demand for the product, and you’ve got one hot commodity! Crude oil is the most sought-after commodity on the New York Mercantile Exchange (NYMEX), and often affects the price of other commodities. So if the demand for crude oil suddenly increases because Americans start driving more or China purchases 100 new airplanes, the price increases. Generally, as goes the price of crude, so follows the price of heating oil.

Worldwide energy supply and demand. Since crude oil is a crucial part of nearly every energy source on the planet, its market price is very closely tied to the global market’s demand for energy. As explained in the October 17 edition of HEAT This Week (“The Stock Market, Heating Oil, and You”), the current economic slowdown affecting economies around the world has weighed down demand for energy everywhere. Americans are driving less and Chinese factories are manufacturing less, putting crude oil in low demand. When the stock market begins to perform more strongly (which some experts say will happen soon), it will be a signal of the global slowdown ending and energy demand returning. At that point, demand for crude oil will surge, lifting its market price and, in turn, lifting the price of heating oil as well.

Profit margins. As with every other good that is bought and sold, petroleum passes through many hands before it arrives at your home as heating oil.

Huge multinational corporations extract crude oil from the ground and ship it to refineries they own nearby to make heating oil. The heating oil is then shipped to local distribution centers called “racks.” At the racks, the heating oil is sold to local retailers, who fill up their tanker trucks and then deliver the oil to homeowners. The two transfers of ownership (multinational producers to retailers and retailers to consumers) include taking of profit from the sale of the oil. If the market value of heating oil is $2 a gallon on the day the retailer buys from the producer, the producer might charge $2.15 a gallon in order to make a profit. The retailer then adds on his own profit margin to the price he charges the consumer, making the retail price $2.50 a gallon. Profit margins are an important part of capitalism, so long as they are fair and justified by market forces. However, heating oil producers and retailers sometimes take advantage of customers and raise the price of the oil to prices that are disproportionate to the market value.

For example, heating oil retailers may raise their profit margins on heating oil during the winter, because they know consumers are more willing to pay higher prices when it’s cold outside. So in the winter, retailers often raise their prices, even if the market price for heating oil is going down. This allows retailers to maximize their profits during heating season so that they may continue to do business when demand is extremely low during the spring and summer. Retailers will argue that this is a fair practice, but some view it as exploiting heating oil consumers.

This tendency of retailers to maximize their profit margins led heating oil collectives like HEAT USA to provide price protection to their members, which compels retailers to agree to a specific number of cents per gallon in profit.

The three factors above are the basic forces that affect the price you pay for heating oil from the moment crude oil is pumped out of the ground to the moment the delivery truck fills up your tank. Crude oil availability and market price, worldwide demand for energy, and profit margins taken along the supply chain are all determined by hundreds of secondary factors that change every day, making the price for a gallon of heating oil change every day as well. With so many interrelated forces guiding the price of heating oil, along with the global economy’s first major crisis of this century, heating oil prices will continue to swing up and down. And whether the trend of the day or week is low or high, flat or sharp, the only thing heating oil consumers can surely bet on is uncertainty.

This article first appeared in the November 7, 2008 edition of the HEAT This Week email newsletter

Crude and heating oil prices dropped like stones this morning, reflecting intensifying concerns about the worldwide economic slowdown and its effects on energy demand.  Both crude and heating oil were down about 2.6% as of 9:54 am eastern time, at $57.77 a barrel and $1.88 a gallon, respectively.  Recent reports that China’s oil imports declined slightly last month stoked investor nervousness about oil.  A strengthening dollar also contributed to lower prices for oil and other commodities.

HEAT USA price experts confirmed a moderate drop in retail prices this morning, and expect a similar drop, based on the morning’s market performance, in tomorrow’s prices.

HEAT USA Price Report
Today’s average heating oil price per gallon: DOWN $0.07
Morning projection (for Thursday’s average price per gallon): DOWN $0.05

The price of crude fell 6% to its lowest price in 19 months, to $59.33 a barrel.  Heating oil followed suit, losing 4.5% to settle at $1.92 a gallon.  As mentioned in this morning price report, falling stock markets, a stronger dollar, and anticipation of the IEA’s prediction of reduced oil demand tomorrow all contributed to falling prices.

HEAT USA price experts were pleased to announce a moderate drop in retail prices tomorrow.

HEAT USA Price Report
Evening Projection (for Wednesday’s average heating oil price per gallon): DOWN $0.07

Oil sand Image:Technology Review

However valid the theory of peak oil may be, one aspect is certain: the crude oil reserves the world currently relies on as the main source of energy are running low.  So where will the oil of the future come from?  Many industry experts and investors will give a simple answer: the oil sands of Alberta, Canada.

Most of the oil that has been extracted from the ground since petroleum first became a valuable fuel has come from “conventional” sources: drilling rigs that pump crude oil up from naturally-formed underground reservoirs.  As those reservoirs are depleted, oil producers have had to look for “unconventional” sources of oil, the best known of which are oil sands.

Oil sands are basically what they sound like: a thick and sticky mixture of sand, water, and an extremely dense and rich form of petroleum called bitumen.  Extracting the oil sands (also known as “tar stands” or “bituminous sands”) from the ground is easy–producers basically scoop it out of the ground and carry it away to production facilities on an enormous dump truck (see video of oil sand excavation from a 2006 “60 Minutes” story here).  The “unconventional” part of oil sands as a resource is the reclaiming process that extracts the bitumen from the sand.  The process of separating the bitumen from the clay, sand, and minerals is complex and expensive.  The extraction process is also inefficient:  the production of one barrel of crude requires two tons of raw tar sand and large quantities of water (several barrels) and heat (source: ostseis.anl.gov).

The inefficiency of the extraction process makes it expensive–as Deutsche Bank AG analyst Ryan Todd stated today in an article on Bloomberg.com, “The oil-sands oil typically tends to be the most expensive barrel to produce out there.”  The high expense is the main impediment to large-scale oil production from oil sands right now.  The market price for crude must be between 90 and 100 dollars per barrel to make oil sand excavation and extraction economically viable.  With oil currently hovering around $60 a barrel, planned production expansions in the oil sands of Canada have been postponed across the board.

Environmental impact of the excavation and extraction processes also make oil sand resources less desirable.  Although mining companies often pledge to restore mined areas, open pit and strip mining methods are used to clear thousands of tons of oil sand a day from open spaces, decimating the landscape.  Strip mining also creates bitumen- and clay-saturated ponds that are deadly to waterfowl and other birds.  Furthermore, the processing of the sand also releases substantial amounts of greenhouse gases into the atmosphere.

Oil sand mining        Image: CBS

Despite economic and environmental problems, oil sands will undoubtedly increase in prominence as a source of the world’s crude oil.  The expanse of oil sands in Canada is immense–they are estimated to contain 173 billion barrels of oil–the second-largest oil reserves on earth, after Saudi Arabia.  The sheer quantity of this resource cannot be ignored, especially at a time when American “oil independence” is such a hot political topic.  Oil prices will inevitably rise again, and oil sand extraction and production will again be a profitable business.  We can only hope that by then, technological advances will have made extracting crude from oil sands a cleaner, safer, and more efficient process.                                                    

Image: ostseis.anl.gov