EDITOR’S NOTE: With heating season set to begin and oil prices threatening nine-year lows, Oil & Energy reached out to oil wholesalers with some questions about the upcoming winter. We want to thank Sprague Operating Resources’ Taylor Hudson and Irving Oil’s Kevin Mikoski for participating in our coverage.
Oil & Energy: It has been a wild roller coaster ride for oil prices over the last 12 months, and now heating oil prices are the lowest they have been in six years or even 10 years in some areas. What sort of volatility do you foresee between now and next April?
Taylor Hudson, Sprague Operating Resources: Extreme price volatility has been a reality in the energy sector since the late 1990s. With the participation of non-traditional market participants like investment funds, there is little reason to expect day-to-day price volatility to lessen. Despite lower absolute prices, the days of one cent trading ranges are probably gone forever. While price volatility can be difficult to deal with it is important to keep in mind that price volatility also creates opportunities. Sprague introduced Real-Time pricing back in 2003 as a tool specifically designed for retailers to use that volatility to their advantage – rather than just being sideline observers.
Kevin Mikoski, Irving: I see the volatility continuing as the new norm. All trading markets including equities and commodities are now influenced by what is happening across the entire globe. There is so much money being invested and traded in and out of the markets that any slight change in the perception of future events causes major moves in the markets. Also the traders who use the markets as a means of making money (many funds and speculators) and not for price risk management (hedging) actually want the markets to keep moving, because a speculator can make money if the market is moving upwards or downwards but cannot make money if the market just stays level. With the future supply and demand situation being in constant change because of such items as the possibility of Iranian oil coming into the global supply chain, China’s growth (or not), along with the uncertainty of adjustments in the level of U.S. production – I believe the volatility in oil prices is a given.
O&E: What factors are mostly likely to drive wholesale HO prices this winter?
KM: The biggest factor affecting the price of wholesale HO prices (this winter or any other season) is crude oil prices. Of course there are many other factors that do drive the price but crude price is on the top of the list. Along with crude oil are the product inventory levels, which are highly affected by crack spreads (difference between the product value and crude value). If the crack spread is not high enough, product production goes down, however, if the crack spread is at a good level refinery run rates increase to produce as much as possible, increasing inventory levels. Other drivers are weather (winter temperatures), unscheduled refinery shutdowns, the availability and cost of other means of heating, and in recent years the changes in government regulations (currently changing sulfur requirements). The list could go on and on. For this season I see the biggest potential factors being where the price of crude oil is and the winter temperatures. For the past couple of years dealers have been helped by the colder temperatures keeping demand up. Last year the drop in price from the summer was substantial but the demand for heating oil and higher street prices (driven by demand) allowed dealers to still use the higher priced oil (fixed forwards) they had purchased. If the temperatures had been warm the situation could have been quite different for some dealers. Also, the winter temperatures can cause issues with other forms of heating, for example, when Natural Gas has issues the demand on diesel fuel (heating oil) goes up causing tight local supplies and thus short-term spikes in the price of available oil.
TH: Notwithstanding the issues of price volatility we’ve already mentioned, weather will always be the wild card in terms of price influence. And it’s also important to note that severe weather can impact price in more ways than just available inventories. Severe weather has a pronounced effect on supply logistics across the region. Just last year we saw ice in harbors that we hadn’t seen in many years. Extreme weather also impacts barge and ship movements. Those issues can also impact outright price – especially in individual markets. Add to all that the fact that the potential impact of weather extends beyond our region. For example, extreme weather in European markets can influence prices in local markets even though we might not be experiencing the same weather patterns.
O&E: How well supplied is the Northeast for a normal heating season?
TH: We think it’s important to look at last year. Despite an extreme winter, the Northeast was adequately supplied. This year PADD 1 distillate stocks are nearly 17 million barrels higher than they were a year ago, and they are in line with the five-year averages. This is partly a result of a market structure this year that is very different than the one we had a year ago. Current “contango” market structure encourages the storage of inventory. Again, while weather is always an unknown inventories going into the season are solid.
KM: I believe that the Northeast is in good shape supply-wise as we head into the heating season. When looking at EIA inventory reports PADD 1A (New England) has more distillate products than it did last year at this time, and the supply has been building. At this writing the U.S. total is 154.0 million barrels versus 127.8 million barrels a year ago. PADD 1 (East Coast) has 57.7 million barrels of distillates compared to 41.8 million barrels last year. PADD 1A has 7.5 million barrels compared to 5.2 million last year. The lower price of oil along with a carry market (contango) has also allowed companies with storage the ability to store more oil with lower capital being tied up in the inventory. To help keep the area supplied this winter the Irving Oil refinery, which supplies much of the product in New England, is currently going through a $200 million turnaround project called Operation Falcon. It is the largest maintenance and upgrade project in the company’s history.
O&E: How well supplied is the region for an extreme winter?
KM: I think the region is well supplied for the same reasons stated in the last question. Some states can still use the high sulfur heating oil, which adds to the total available product. The majority of the diesel product in the region is low sulfur and ultra-low sulfur, which can also be used in the high sulfur areas if needed. If there is an extreme winter the main issue becomes logistics of getting the product to where it needs to be – ships (oil tankers) can get delayed by the weather but not nearly at the rate barges do. I believe that suppliers will be able to have product available no matter what the winter brings, as long as refineries do not have any major issues. It would take a number of negative factors lined up for the perfect storm to paint the picture of concern for supply. I do not have the plans for other suppliers so I cannot answer for them, but I am confident that our supply chain (Irving Oil) is well prepared.
TH: As stated above, product supply is well ahead of last year’s level so even a repeat of last year’s challenging conditions should not pose a problem for the industry. We think it is also important to remember that a company such as Sprague, with an extensive terminal network and the logistical expertise to keep the system wet, should be viewed as a vital supply partner for your readers. Furthermore, Sprague has the price management tools to help customers mitigate the risk of an extreme winter by offering them programs to protect themselves in the event of an extreme winter without necessarily having to take an absolute price position.
O&E: Three years from now most states will be at 15ppm sulfur, but for now there is still a hodgepodge of specs in 2015. Will suppliers continue to store and sell higher sulfur distillates? Do that economics continue to support that approach?
TH: In the states where the use of high sulfur heating oil is still permitted, Sprague will have high sulfur fuel for sale. As it has always been, Sprague’s objective is to be a reliable source of supply for the products our customers want in the markets they want them.
KM: For the coming season I would say that the different sulfur products will definitely still be stored and sold. It will vary by location with the availability of storage and supply. Suppliers will start to have a diminishing supply of high sulfur (greater than 500ppm) product as refineries produce more of the ultra low sulfur diesel (ULSD 15 ppm) going forward. The deadline for most areas in New England to be selling only ultra low sulfur heating oil (ULSHO 15ppm) is scheduled for July of 2018. I think you will see the availability of higher sulfur products diminish ahead of that deadline. The economics continue to make sense in some areas, but that is still a matter of the availability and the economics of each individual location. The majority of dealers are still looking to buy at the lowest possible price and as long as there are even fractions of a cent to be saved by buying high sulfur or low sulfur (500ppm) heating oil, they will buy it.