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.

Heating oil customers know that the price of heating oil changes every day, even every hour.  With so many different forces influencing the price of heating oil–the price of crude, weather, location, and others–the price per gallon of heating oil can go up or down by a full fifteen or twenty cents in one day.  Market price for heating oil is currently 75 cents higher per gallon than one year ago, but a full dollar lower than two months ago.  This price volatility has become a reality of the modern heating oil business, and is the main reason that locked-in pricing is a risky choice.

The basic danger of locking in your heating oil price for any amount of time is that if the price of oil goes down, you are stuck paying a higher price.  Obviously, the inverse situation (being lucky enough to lock in a low price before prices take off on a long-term rise) is also possible, but there are other factors to consider.  In addition to tying you to a price, locked-in pricing agreements tie you to a contract–an agreement that, as soon as you sign on the dotted line, reduces your leverage in dealing directly with your heating oil dealer.  The price-lock contract guarantees you as a customer to the heating oil dealer for a certain amount of time (usually one year).  The contract eliminates your option of “voting with your feet”–seeking out a new dealer –if you are dissatisfied for any reason.  Of course you can get out of your fixed-price contract, but it will cost you a cancellation fee of several hundred dollars.  Furthermore, if your dealer has you on contract, he will be less concerned about losing you as a customer, which makes you a lower priority than non-contract customers when it comes to service and deliveries.  If a dealer is late for a service appointment with a non-contract customer, he risks that customer ordering from a different dealer for her next delivery.  If a dealer is late for a service appointment with a contract customer, he essentially risks nothing.

An article in today’s Ridgefield Press (Ridgefield, CT) shows an example of bad buying practices resulting in unnecessarily higher costs.  The Ridgefield school board made some unfortunate buying decisions that led to their paying an extra $250,000 to heat Ridgefield schools this winter.  Their loss was a direct result of this summer’s price spike–although the board had laid out a plan for regular buys dictated by time and not price-per-gallon, the record-high prices caused great concern that prices would continue to go up.  Shaken by this concern, the board abandoned their buying plan and made a large purchase at the near-peak price in late May.

Mark Kohan, a pricing expert and Membership Services Director at HEAT USA knows of a few HEAT members who made the very same mistake:  “When prices were so high earlier this year, we had a couple members leave the co-op to sign contracts that locked them in at $4.699 and $4.899 per gallon, plus the cost of service.  They were afraid that prices would keep going up.”  Now that prices have come down by about 70 cents per gallon, he says, “those same members are choosing to pay the $300 or $400 cancellation fees to re-join HEAT USA.  They looked at paying $4.89 per gallon all season and realized that, even after paying the cancellation fees, they would save money with the co-op.”

The best option for heating oil consumers is to rely on the assistance of pricing experts and consumer advocates provided by buying co-operatives like HEAT USA.  Membership in a large buying organization means professionals empowered with unique market information are watching prices on your behalf every day.  In addition, membership puts the full influence of tens of thousands of other consumers behind you, making you a high-value customer that dealers want to keep happy.