On October 8th of this year, the Energy Information Administration (EIA) released its short-term energy outlook, warning of substantially higher heating and energy costs this winter. That same day, HEAT This Week applauded the EIA’s cautious estimates, but questioned their accuracy. In the October 8th newsletter, (“What to Expect this Winter,” read the entire article on The Heat Zone blog) HEAT USA president Andrew Heaney explained that the EIA’s report ignored important economic evidence that crude oil and other energy prices would continue to decline sharply for several months, at least.

It looks like the EIA has come around to HEAT USA’s point of view. On November 12th, the agency released its November Short Term Energy Outlook, which essentially reversed the position set out in the October report. The EIA summarized its new position in the report’s top bullet point:

The current U.S. and global economic downturn has led to a decrease in global energy demand and a rapid and substantial reduction in crude oil and other energy prices. As a result, projections for both energy demand and prices are considerably lower than last month’s Outlook.

The new report offers good news for consumers of all petroleum products: heating oil, gasoline, propane, and natural gas users will all pay less for their fuels this winter than they did in 2007. As for heating oil, an Associated Press article specified that heating oil users are expected to pay $1,694 for oil this season, a 13 per cent decline from last winter, and almost $700 less than the EIA’s October prediction. The report forecasts the average heating oil price per gallon this winter will be $2.75, a 56-cent reduction from last month’s report and 17 per cent lower than last winter’s average price. In addition to plummeting worldwide energy demand, consistent increases in crude and heating oil inventories in the US have also contributed to lower retail prices, according to a Reuters article that noted heating oil inventories had risen by 1.3 million barrels in the last week.

The news appears to be consistent throughout the Northeastern states. According to the Scranton Times-Tribune, heating oil prices in Pennsylvania have fallen 15 per cent in the last month. The Boston Herald reported the average price in Massachusetts to be $2.85, 31 cents lower than November of 2007.

Of course, because the EIA’s reports come out every month, December could bring yet another drastic change in the short-term energy outlook, but that is unlikely. Because low oil prices are primarily a product of dwindling energy demand around the world, major price increases would have to be brought about by a resurgence in energy demand. While energy demand will almost certainly return to the early 2008 levels that caused record-high oil prices, it will not happen in a matter of days or weeks, but months or years. Heating oil prices will continue to fluctuate, but consumers throughout the Northeast can look forward to lower prices than last winter for at least the next two or three months.

NOTE: This article first appeared in the November 14th, 2008 edition of the HEAT This Week email newsletter.

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

Image: AP/Wall Street Journal

Although oil prices surged today, the $70 per barrel price is nearly 25% lower than this time last year and 50% lower than the peak of $147 reached in July.  This morning, investment bank Credit Suisse made the case that oil prices will continue to drop for months to come.  Th bank revised its oil price prediction for the second time this month, reducing its 2009 prediction to $60 a barrel (from $70) and 2010 prediction to $80 a barrel.  Bank researchers cited the effects a global recession will soon have on China, the world’s second-largest oil consumer after the United States, as the main cause of their reduced price projections.

As an article in the Wall Street Journal reported, Credit Suisse forecast 7% economic growth for the next three quarters in China, a substantial reduction for the world’s fastest-growing economy, which has enjoyed double-digit growth of its gross domestic product (GDP) since 2002.  If Credit Suisse’s prediction plays out, China’s GDP growth will fall below the 8% mark that the Chinese government has stated as necessary to accommodate the massive rural-to-urban demographic shift that is underway in that country (source: Guardian UK).  Resulting problems would only further disrupt China’s humming manufacturing sector, which has already shown signs of slowing down in response to decreased demand for consumer products in the US and around the world.

As China has risen to take its place as a dominant economic force in the global economy during the first decade of the 21st Century, it is no surprise that it is poised to be hit hardest by economic crises from other parts of the world.  Sparked by a global recession, a slowdown in China’s production apparatus would lead to reduced demand for oil and keep oil prices low.  And that is how a factory in Beijing shutting down could lead to you paying lower prices for gasoline and heating oil.

Sen. Chuck Schumer Photo: nypost.com

Senator Chuck Schumer (D) of New York called a press conference Sunday, during which he stated that heating oil prices are not falling as fast as crude prices, and that greedy Big Oil is to blame. Citing his own research (most likely done by his staff), Schumer noted that the price for a barrel of crude oil has dropped by 50 percent since its peak price in July, while the price of heating oil has only dropped 12 percent in the same period of time (source: newsday.com).  He also noted that gasoline prices had dropped more than heating oil prices (23 percent since July), but that gas prices are “still not where they should be.”  He called for the Federal Trade Commission to warn oil companies across the country to lower their heating oil and gasoline prices to match crude prices or face “stiff penalties.”

Schumer has been a longstanding ally of heating oil consumers. No matter your politics, you must acknowledge that he has brought heating oil issues to the fore of national discussion on more than one occasion, and has been instrumental in securing additional HEAP funds for low-income households in the State of New York.  In this case, his statistics shed light on a frustrating reality: the price of crude has dropped tremendously over the last four months, and heating oil and gasoline prices have only declined modestly.  While oil companies’ hunger for profits is certainly one explanation for this situation, it is not the only one.

Heating oil and gasoline tend to follow the same price trends as crude because crude is the main ingredient in both fuels, but the correlation among the three is not directly proportional or even consistent.  It is important to remember that crude, heating oil, and gasoline are all traded as separate commodities on the New York Mercantile Exchange, and therefore go through independent buying and selling cycles.  Furthermore, heating oil and gasoline have opposite demand seasons, with demand for heating oil trending upward in the winter and demand for gasoline trending upward in the summer.  Also, the production and distribution channels of heating oil and gasoline are very different.  Huge multinational oil companies manufacture heating oil from crude and then sell the heating oil to local distributors around the country, who then sell the oil at retail prices to consumers.  Gasoline is a different story–”Big Oil” companies like Shell and Exxon control the gas from the crude pumps all the way to the gas pumps–the producer, manufacturer, and retailer are all the same company.

Decades of collective experience have taught the HEAT USA price team that today, the only dead-certain prediction in the price of heating oil is uncertainty.  It’s this uncertainly that led HEAT USA to create the Fair Price Protection Program, which limits how much heating oil providers add to the wholesale price when setting daily retail prices.  HEAT USA members are assured that, if the market price of wholesale heating oil drops, their retail prices drop immediately.  Under Fair Price Protection, heating oil retailers’ profit margins are fixed to a specific number of cents per gallon.

Whether or not Senator Schumer’s call for action is heeded by the FTC, the crude oil and heating oil markets will continue to bounce up and down in the coming months, and the best and most reliable support for consumers is the support of large buying groups like HEAT USA and the guarantee of fair prices that they provide.