The price of crude in 2008 Image: FinancialTimes.com

As 2008 draws to a close, traders and analysts on the on the oil markets are happy to see it go.  The price of crude oil fell 54% from its peak in July, the largest annual decline since 1983, as a global economic crisis sapped fuel demand and froze lines of credit.

So what is in store for the oil markets in 2009?  It is of course impossible to predict where crude and heating oil prices will go, but chances are, after this year’s historic declines, they will be moving upward, gradually or quickly.  Whatever happens to oil prices, we can be sure of a few key factors exerting the most influence.

OPEC discipline.  OPEC nations have lost the most as a result of low oil prices, and have taken drastic action in an attempt to turn that trend around.  The organization has announced production cuts of over 4 million barrels a day since September.  The important question is: will all of the member nations comply with the cuts?  Many once-skeptical analysts are predicting that they will.  OPEC nations (especially smaller producers such as Venezuela and Libya) have a long history of agreeing to the cuts that they then neglect to implement, for fear of losing short-term revenue.  According to a Wall Street Journal article, the first annual decline of crude prices in seven years has given OPEC a “newfound discipline” that will translate to almost-full compliance with the production cuts by February of 2009.  In an interview with CNBC.com, oil expert Azlin Ahmad, editor at Argus Media, called OPEC’s discipline the most important factor in determining oil prices in 2009 (watch the video here).

The global recession.  Oil prices plummeted in 2008 largely because of slumping demand in the world’s biggest oil-consuming regions (the U.S., Japan, and Europe), which in turn led to slowing growth and diminished demand in developing nations like China and India.  When credit begins to thaw and consumer economies like the U.S.’s begin to recover, they will kick-start the huge producer economies of India and China.  Americans will begin to drive more again, and the factories in developing nations will need huge amounts of oil to get humming again.  As demand returns around the world, oil prices will climb.  In her CNBC interview, Ms. Ahmad called slumping demand the “main problem” in oil prices today and predicted that developing nations would continue their economic growth and maintain a (smaller than before) demand for oil.  This demand may or may not be offset by low demand from developed nations, she said.

Geopolitical events.  On Monday of this week, the surge in oil prices in response to Israel’s military campaign in Gaza reminded us that geopolitical events can cause huge swings in oil prices.  If Iran decides to enter the conflict and deny Israel’s allies oil, prices could soar.  If Iran’s radical president Ahmadinejad is replaced by a moderate less hostile towards the west, prices could fall fast.  As unpredictable as the weather, elections, wars, trade agreements and other evens around the world could have profound effects on the oil markets next year.

Depending on those three main factors, oil prices in 2009 could post a great recovery or a great continuation of 2008.  Only time will tell.

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.

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

Commodities prices fell along with the stock market in early trading on Monday.  As the details of an eleventh-hour deal on the government bailout bill for the financial sector emerged, traders seemed to doubt that the bill, if it does pass a Monday vote in Congress, would provide adequate measures to avert a forthcoming economic slowdown.  A Bloomberg.com article quoted David Moore, a commodity strategist at Commonwealth Bank of Australia in Sydney, on the state of the markets: “Even if the Troubled Asset Rescue Plan is passed, that doesn’t necessarily mean there aren’t any obstacles on the road to economic recovery.  There are worries about the outlook for the international economy.”

As of 9:30 Monday morning, crude oil had fallen over $5 from its Friday closing price and hovered around the $101 per barrel mark.  Heating oil dropped as well, down almost 5% from its Friday closing price.

After a record breaking one-day gain on Monday, a big drop-off on Tuesday, and a small loss on Wednesday, Crude oil prices rose modestly on Thursday, ending just shy of  $108 a barrel, as reported by CNNmoney and wsj.com.  Stocks rose and the dollar strengthened as traders showed optimism that the $700 billion government bailout of the financial market was close to completion.  Declining demand, supply interruptions and lower-than-expected stockpiles of crude and gasoline were all overshadowed by the question: how and when will the government remedy the current economic crisis?  Heating oil also rose slightly, up 2 cents to $3.05 per gallon.

The New York Times reported this morning that the Commodity Futures Trading Commission has issued subpoenas in its investigation of possible illicit manipulations that may have caused the unprecedented jump in crude oil prices on Monday. The subpoenas were issued for trading records from several oil trading companies involved in trades on the crude oil contract for October delivery, which closed on Monday at $120.92 after posting its record gain. In addition to subpoenaing records, the CFTC can also compel sworn testimony from individuals involved in the crude oil market. The Heat Zone will publish the details of the subpoenas and any testimonies as they become available.