Thursday, June 8, 2023


Risks & Returns


A cursory glance at The Diff. on page 3 of our April 2019 issue shows the New York Harbor price for No. 2 Fuel Oil and No. 2 ULSD resting comfortably just under $2.00, at $1.977 and $1.999 respectively. The Barometer, also on page 3, lists WTI Crude at $56.79/barrel and Brent Crude at $65.06/barrel, both prices only slightly higher than at this time last year.

Flip over to The Stats Page (46) and you’ll find total distillate stocks up some 3 million barrels from March 2018, including a sizable gain in New England’s ultra-low sulfur distillate inventories. That same page lists temperatures for 2018-19 as only 2 percent warmer than normal, with 1% more degree days than normal in marketplaces including Albany, New York and Worcester, Massachusetts.

(Editor’s Note: Want access to The Diff., The Barometer, The Stats Page and other monthly columns? Subscribe here.)

Taken together, these numbers might be seen as a smoothing of the tides for the heating oil market. But such simplification belies the market’s underlying complexity. There are also regulations, politics, and many other factors to consider. As new challenges and opportunities emerge, heating oil marketers look for new strategies to benefit their businesses and protect their customers.

Oil & Energy recently reached out to hedging providers who support the heating oil market for their thoughts about the current marketplace and prospects for 2019-20. We’d like to thank the companies that took the time to participate: Hedge Solutions, Global Partners LP, Sprague Operating Resources, Angus Energy, Aletheia Consulting Group and Irving Energy.


It seems that volatility has “returned” to the crude oil market: during the last three months of 2018, crude oil prices declined by some 40%. Did these market conditions “trickle” downstream to the distillate markets, and if so, which, if any, hedging strategies could have helped?

Hedge: Yes, absolutely, ULSD tracked crude prices lower, almost to the penny. WTI prices dropped $34/barrel, about an $.81 product equivalent. ULSD prices fell $.82/gallon in the same time frame, from $2.46 to $1.64 per gallon. Therefore, any product hedged back in the typical timing for hedging cap programs — say March through July — would have been priced from a low of $2.00 to a high of $2.30 basis the futures market. An options’ hedging strategy in this case would have allowed your costs to drop with the oil prices. Without this hedge, the dealer would not have been able to drop their price without losing profit margin.

Global: There was a decline in the price of distillates for Q4 2018; close to a 30% drop from where the HO ticker was trading on 10/1/18. Lower prices helped some dealers take advantage of the prompt market by buying, in real time, 3-10 day contracts – a so-called “buy-what-you’re-selling” strategy. Predicting a market downturn is rarely possible. However, in hindsight, one potential solution for a dealer would have been to lock in a portion of its business with fixed price contracts and purchase downside protection for fixed pricing. By implementing this strategy, a dealer’s remaining business could then be priced at the spot market, allowing the dealer to leverage real-time contracts to take advantage of the falling flat price.

Sprague: The old saying that “crude is king” holds true. The reduction in crude oil prices most certainly resulted in reduced wholesale distillate prices. As a result, retailers enjoyed strong margins as wholesale prices fell faster than retail prices. By far the hedging strategies that worked best were for the retailers that chose some form of downside protection program (like Sprague PhysCap), as they were protected throughout the price slide.

Angus: Firstly, price declines (or increases) are not, by themselves, the equivalent of “volatility.” As to whether distillate prices followed crude oil price lower, they absolutely did. ULSD fell by about $.75/gallon during the 4th quarter of the year – before rising about $.35/gallon through the end of February. Hedging strategies should always be to offset risk, so the question could only be answered in the context of whether or not there was “risk” to a distributor that was correlated to falling (or rising) prices. The bottom line, based on Q4 2018, is that retail margins should have ended the year with the double benefit of rising margins and high sales volumes.

Aletheia: Long-term strategy: taking advantage of the price decline is precisely what many energy marketers did by purchasing a percentage of next year’s price protected gallons when the market fell. Too often energy retailers miss purchasing opportunities during the current heating season because they are so focused on getting through the season.

Short-term strategy: think like a wholesaler! Wholesale suppliers are constantly buying and selling as well as hedging. Are you hedging your short-term exposure? I always remind clients that anytime product is fixed via a supplier’s energy desk or online, you need to give careful attention to how long the product will remain in your tank without a sale. Not moving the product quick enough can lead to substantial downside risk. To combat this risk, you can buy put options or sell call options to mitigate your downside exposure.

Irving: Volatility did return at the start of this season, especially November-December, which has happened during winter seasons of most recent years (last winter of 2017-18 was an exception). The volatility index came back down quickly to a more moderate level by mid-January. The trickle down from crude oil to the products is to be expected. That being the case, those dealers that have customers locked into a higher fixed price and do not collect money from the customer up front run the risk of them shopping the market and trying to run out on the deal. This season, the price of distillate did drop but not nearly as much on the street as it did in the spot markets. Since the retail cash market did not drop as significantly as in some prior years, it was not as big an issue as in many past seasons.

Using some downside protection, either with call options or fixed price purchases with put options, can help minimize the risk if the market does drop. In any year, the volatility of oil prices and the uncertainty of what direction prices will go are always there. Therefore dealers need to buy forwards against what they are selling and not guess what is going to happen in the following winter. Hedges are meant to prevent loss — not to make extra income — and speculation trying to make money can get any of us into trouble. If you are going to speculate, do not tie it to your core business, but instead open a trading account and keep it separate from your product/sales hedging.



On the other hand, it seems normalcy has “returned” in terms of the Northeast’s cold winter conditions. In your experience, were heating oil dealers successful in getting more customers onto budget plans and price programs after the winter of 2017-18, and if so, how might this have affected their costs and hedging strategies during the current heating season?

Global: After the winter of 2017-2018, there was a higher demand from end user customers to lock in pricing either through fixed price contracts or basis contracts. Because more end user customers were locked into pricing programs, dealers had the opportunity to hedge pricing and protect against the market downturn. Not all dealers offer end user customers the opportunity to lock in pricing, instead electing to price at the spot market. It did, however, appear that the market, on the whole, demanded more certainty this year and contract pricing bore that out.

Sprague: While buyers of downside protection programs certainly fared best this season, it is difficult to say that retailers recruited more homeowners into budget programs for 2018-2019 than the prior season. In fact, the hangover from the price slide of 2008-2009 dramatically reduced both the offering and participation in price protection programs and that has never fully recovered. Nonetheless, great programs do exist for retailers that want to offer them and this past season is great evidence that they work.

Angus: Interestingly, winter 2017-18, despite the extreme volatility of the weather, won’t appear as a season with dramatic price movements or one with basis blowout issues. The value of budgeting and pricing programs certainly wasn’t hurt, but there were no dramatic “Price Events” that drove hordes of customers back to pricing plans. As to the costs of hedging, in my experience pricing programs and their related volumes have little impact on the cost of the hedge, as these volumes are easily absorbed into the marketplace. The impact on hedge costs is almost solely related to the Implied Volatility, or the perceived risk factor.

Aletheia: After a period of declining price protection programs, I am seeing an uptick in budget cap enrollments for two reasons. Reason one: consumers are more open to monthly fees and yearly memberships (think Amazon Prime, Netflix, Spotify, Costco, etc.) as long as the expectation of good value is attained. Reason two: the cost to hedge has decreased significantly, which gives both the retail energy marketer as well as the consumer a more appealing program to be involved in.

Irving: This is a question that could be best answered by the dealers. It seems that since prices and demand were lower during 2017-2018, customers were less likely to sign on to plans as quickly. With the uncertainties of the change to ULSHO and associated prices, dealers and customers waited until later in the year to lock in. From our experience, customers did come in and buy but later rather than early in the buying season. Whenever current prices are lower during the spring/summer buying season than the forward prices, or prices during the past winter were lower than what customers had locked in, there is a hesitancy to make a commitment for the next season.

Hedge: I would say yes, though it’s hard to determine what is “normal” or typical these days. We service hedge programs for over 100 companies, so I feel like we have a pretty good view of what the consumer is doing these days. As all are aware, the 2017-2018 heating season produced the tale of two extremes. It got intensely cold early on in December and January only to warm up in the back half. The intensely cold 3-4 week period really stressed out the resources of most heating oil companies. Images of consumers running out of oil and waiting for deliveries were popping up on the evening news and across social media. The majority of the problems, by far, were from the will call delivery group. Consumers on a budget or automatic delivery regimen were watching these stories in a warm home with a full tank of oil. Though mostly anecdotal, the feedback was that this carried over to the spring and summer when it came to renewing the budget accounts, signing up for price protection, and staying on automatic delivery. The end result is that most consumers realized a savings if they enrolled in price protection.


Distillate stocks, which had been significantly lower in early 2018 than in early 2017, seemed to bounce back for the current heating season as well. To what do you attribute this, and do you see it as a good sign for the future?

Sprague: Positive refining margins meant the refinery run rates were very high, resulting in inventory builds. It is a good sign, because stocks will need to build ahead of IMO 2020 (Jan. 1, 2020), when global demand for distillates could increase significantly, with estimates in the 1.5-3.0 mb/d range.

Angus: It seems that early 2017 witnessed an anomaly in inventory levels, and one that was and is being addressed by OPEC+Russia. I don’t know that it is good or bad, as the market seems to have a way to self-regulate with an attempt to balance the benefits of higher prices (for producers) against the risk that high prices will increase production, ultimately driving prices back down. It is a hard balance to strike, but that is the stated goal of most of the world’s producers.

Global: There are likely a variety of reasons for the bounce-back of distillate stocks this heating season. For example, the uniformity of distillates due to the 15ppm sulfur standard helped alleviate storage concerns. In addition, weather normalization helped to keep product moving through the harbors, avoiding major supply disruptions while keeping trucks and racks busy. This was all positive news for this heating season and hopefully beyond.

Irving: The spread between gasoline values and distillate values — gasoline currently being much lower than distillates, but narrowing as we approach the summer driving season — would have refiners producing as much distillate as possible to maximize crack spread margins. Gasoline values have been negative at times when compared to crude oil. The maximizing of distillate production helped to keep Northeast inventories at sufficient levels.

Another factor that plays into supply of distillate stocks is the change to ULSHO and ULSD being basically the same product during much of the year. This flexibility of being able to use the product where the biggest demand is allows for better use of storage and allows supply availability when needed for a desired use. In recent years there was a significant spread between ULSD and HO prices, making it uneconomical to use ULSD as heating oil. But now the pricing is nearly the same (ULSHO being lower because of RINs obligations for ULSD). When heating oil is in big demand during cold weather and storms, more of the product can shift from ULSD to ULSHO, allowing inventories to balance and minimizing chances for a major shortage of either product.

One other factor that helped to bounce inventory levels higher in the Northeast was a year without any major storms to cause long-term setbacks/delays in supply.

Hedge: The “almost” final phasing in of ULSD to the heating oil market has definitely helped in keeping East Coast terminals amply supplied for the heating season. Adding to this factor was that ULSD crack spreads widened considerably in Q4 2018 and Q1 2019. East Coast refiners also picked up the pace at the end of the year.

Aletheia: It is really as simple as supply and demand. High prices lead to more production domestically or via imports. Low prices lead to less production domestically or via imports. The current historic highs in U.S. oil production have been a godsend to everyone involved in the petroleum industry. Domestic production has kept a lid on prices and brought tremendous leverage back to the United States.


Did New England’s transition to the 15ppm sulfur standard play out in the markets as expected, or did you observe any unforeseen consequences or side effects?

Angus: I’m very impressed with the way that the markets — refiners, pipelines, other transporters, wholesalers, states and retailers — handled it. There were very few “blips on the radar,” a testament to the value of preparation time.

Aletheia: Having worked for a refiner, I can appreciate how challenging it is when new specifications are mandated. I am impressed at how refiners can adapt seemingly so smoothly to the constant changing market dynamics. The move to 15ppm is great news for the home heating retailer for a couple reasons. Reason one: with the transition to renewable energy, the 15ppm standard serves as an excellent base stock to the blending of various bio blends. Reason two: major oil suppliers are returning to the heating oil market since all the product can be stored in one tank with dye being added at the rack to differentiate between 15ppm on-road diesel and 15ppm heating oil. A better product and more competition in the marketplace are great news for the energy retailer.

Hedge: Normalization is the term I would use. As I mentioned above, the ubiquity of standardizing the product has been very helpful. The phasing in of product specs in New England and New York over the past several years had its issues. This was reflected mostly in the basis, the differential between the spot NYMEX price and the rack price at the local terminals. This phenomenon likely caused basis to be a bit higher than normal. Now that all heating oil states, with the exception of Pennsylvania, have moved to ULSD, I believe you have seen a return to normal. This is reflected in the data.

I believe very strongly that the move to ULSD has had its biggest impact on the consumer. The lower sulfur fuel has resulted in a much cleaner heating chamber in the furnace or boiler. The optics of the service tech walking out of their basement after doing a cleanout on their heating equipment — minus the soot that formerly was always present — has had a big impact on the consumer’s view of this heating source.

Irving: I think the transition went pretty much as expected, with the biggest issue being some individual states not giving enough timely direction on their expectations. Standardization of products can have beneficial results, as I mentioned. I do not believe fuel standardization is good when it is tied to government-subsidized rebates/credits. If products cannot stand on their own (with the exception of critical issues with products, such as public safety, verifiable pollution, etc.), they should not be mandated. Having standards, such as having distillate sales use a standard based on net gallons in all the New England states instead of varying from state to state (gross gallons in some and net in others), would be beneficial to both suppliers and dealers.

Global: The uniform 15ppm sulfur standard seems to have helped streamline supply, as distillate product is now of the same quality. The implementation of the uniform standard was a bit choppy at first; however, now that all of the storage tanks have turned over, the uniform standard seems to have added stability to the Northeast market from a supply and storage perspective.

Sprague: All product transitions have their wrinkles, but all in all, the transition to a single 15ppm distillate pool went as smoothly as could be expected with credit going to the New England states that allowed for a natural blend-down to 15ppm sulfur rather than a hard July 1 deadline. This certainly made the most sense for the industry.


EIA anticipates that the new sulfur limits for marine fuels (IMO 2020) will widen price spreads between high- and low-sulfur petroleum products. Do you foresee any related impacts beyond or apart from those EIA has already predicted?

Hedge: There are all kinds of hyped up scenarios being pushed out there in this space. It reminds me of the switch in RBOB (gasoline) specs years ago. It’s hard to say which, if any, of the scenarios will prevail. It’s difficult to assess the impact, because we don’t have clarity on a variety of the logistics. What will the enforcement be? Will there be a high level of blending? Will they scrub and how much? What will the level of compliance be? I think the one sure thing will be that you can count on a high level of speculation on this. That usually means we see more volatility until we know and see results and data.

Sprague: The subject has been widely covered and most of the implications are out there, but as always, there could be some unintended/unanticipated consequences as the deadline draws near.

Irving: The International Maritime Organization (IMO) is a United Nations Specialized Agency. Its mandated sulfur limits could have a greater impact than what many see at first glance. Besides a direct price implication, there could be some supply issues. The demand for marine distillates is currently being estimated by the EIA, but a major unknown is how many vessels will install scrubbers or may even convert their vessels to LNG instead of fuel oil (much smaller number anticipated). The various fuel oils to be available will be high sulfur fuel oil, low sulfur fuel oil, and MGO (marine gas oil, a lighter diesel fuel). The mix is unknown at this time and many analysts are expecting the new requirements to add over 1.0 million barrels per day to current distillate demand (some estimate over 2 million). This could cause some spikes in basis that would potentially affect ULSD and ULSHO prices. The biggest risk is going to be during this first year of the new laws. Many reports are addressing the changes, and there is a wide range of expectations and thoughts about how this will impact supply. It will have an impact, but how much is unknown at this time. One thing we can be sure of is that if there are any impacts it will be higher prices and/or available supply shortages.

Altetheia: Refiners will increase production of higher value distillates in order to meet the increased demand resulting from the International Maritime Organization’s new regulations, which go into effect by 2020. This is going to put pressure on the utilization rates of refineries. Any refinery problems will potentially lead to basis spikes. One way to combat this risk would be to think like a refiner and put crack spread hedges on.

Angus: I’ve been hearing and reading about this for a while, but haven’t seen it yet.


What are your thoughts on the OPEC-Russia output cuts? If these factions formalize their pact, how might that affect the markets moving forward?

Angus: I think Russia is playing it brilliantly. They are “in” when good for them, and “out” when good for them. That said, short of a concerted effort to squeeze the markets out of aggression, the counterbalance of shale production in the U.S. seems to be the differentiation that will continue to “keep everyone honest.”

Hedge: This always comes down to compliance. History has proven this to be an unpredictable equation. The Saudis have been the primary determinate over the past two agreements. Watch Russia in the spring. They have to show discipline or traders will become wary.

Aletheia: Even with record production domestically, the OPEC-Russian alliance still holds substantial leverage in keeping prices elevated. Another factor affecting markets moving forward would be politics, especially here in the United States. The current administration is pro-domestic energy production, but if President Trump isn’t re-elected then the potential for a substantial change in energy policy is inevitable. More government restrictions on conventional fuels would no doubt mean higher prices.
Sprague: The production cuts have already succeeded in moving prices higher, and a formal pact would give them the ability to have even greater success in supporting prices in the future.

Irving: If the output cuts stay strong and are extended as Saudi Arabia indicates, prices in the coming months will be supported. The successful cuts in production will help keep a floor on prices. These cuts are being combined with other involuntary production cuts caused by issues such as the political problems/sanctions in Venezuela and sanctions on Iran. The impact of the cuts is going to be highly dependent on the world’s economic situation. If world economic growth is good, demand will be high, putting a squeeze on available supply and pushing prices higher (aided by the cuts). On the other hand, if the world economy slows, the OPEC-Russia output cuts will have a very small impact on keeping prices higher, especially if the U.S. continues to increase production and lead the world in total record output.


Do you think basis spikes or other volatility-related risks are more likely to materialize in the coming year? If so, how can hedgers mitigate their impacts?

Sprague: On one hand, a single distillate pool and stronger inventory levels should mitigate the chances of a distillate basis spike in the coming year. On the other hand, that could be offset by increased distillate demand as a result of IMO 2020. Either way, a reasonable measure of basis protection has always proven to be a sound strategy for retailers, whether they offer price protection programs or not.

Global: The last several years have shown that markets can be volatile for all products, including distillates. It is impossible to really know whether basis spikes or other volatility-related risks are more likely to materialize in the coming year, as a number of catalysts could cause market shocks. Therefore, it is important to properly manage risk. Avoiding major speculative positions and making sure inventory and sales positions are hedged correctly are prudent steps to take. In addition, purchasing basis contracts allows a dealer to lock in a differential for forward purchases based off today’s index-related pricing. This approach helps to mitigate against so-called “basis blowouts,” but does expose the dealer to “basis collapses.” Whatever the approach taken, the key is to minimize exposure and use whichever strategy or combination of strategies fits one’s particular business.

Irving: Risks of basis spikes or any other price risks are always present in energy markets. The important thing to avoid potential loss of margins is to make sure you buy gallons with a fixed price to cover your forward sales. If a dealer is using call options to hedge, they must remember that unless the option is tied to their cost base (such as Platts or Argus), they will not be protected from a basis spike. A dealer can also lock in a forward differential to the NYMEX for the winter months so that they will not be exposed if there is a basis spike.

Hedge: The heating oil share in the ULSD pool has become so small that it has lost most of its influence on price, at least in the futures market. That said, when extreme cold couples with low storage in the Northeast, problems can always pop up. It makes sense to always have some contract oil (wet barrels) in the mix when hedging. We always advise as to when and where you should have this contract oil, as it can have a sizeable impact on cost.

Aletheia: Basis spikes create a lot of fear in the minds of retailers, but careful analysis needs to be done. A frequent conversation I have with clients is risk/reward, meaning how much does a particular strategy cost vs. the perceived benefit. You can hedge basis with either paper (basis swaps or options) or wet barrels (fixed price or fixed diffs unpriced). When contemplating hedging your basis, it is helpful to watch export numbers. If exports remain high then that would mean less of a need to lock in our basis (increased exports mean other countries need the product more than the United States and are willing to pay a higher price). In fact, locking in your basis can actually be detrimental to your margin. A well-supplied market (high exports) could mean an actual decrease in rack basis. When wholesalers look for buyers, more competition occurs at the rack, thus shrinking basis. Any retailers who didn’t lock in supply (wet barrels) will now be making more margin since the basis will be lower.

Angus: We leave price speculation to others. Not that speculation is bad, but our clients seek hedging advice — and that advice is very consistent: measure your risk in terms of price, volume and basis; assess how much of that risk you want to take on; and how much of that you want to push off on others, a/k/a hedge.


Are there any new hedging products, programs or services that you are offering in 2019?

Global: Global has a variety of different hedging tools to help dealers minimize risk. Global offers fixed forward pricing for full and partial contracts, as well as prompt contracts over the phone or online through the GlobalCONNECT Portal. Global sells contracts based upon standardized heat curves, customized monthly volumes or on other terms to fit a variety of needs. Spread and basis contracts are available to lock in current basis for future gallons. Global also provides downside protection products for fixed pricing to help ensure against falling flat price.

Hedge: Yes, we have developed several strategies around hedging cap programs over the past three years that have been piloted with documented results. We are also launching the new Hedge Insite software, which we are really excited about. It is as flexible as an Excel spreadsheet, with all the security and reliability of a database. It has been beta tested for a year and is now ready for launch. We will be demonstrating it at the Eastern Energy Expo in May.

Sprague: Sprague has a solid slate of hedging programs for retailers: everything from basic standard and small-volume fixed-forward contracts, unpriced guaranteed differentials (UGDs), small and full-volume HeatCurves, and downside protection programs like PhysCap and PriceFlex. Over the years, these programs have proven to work for retailers across our marketing area. The key is choosing the program that best matches what a retailer offers.

Angus: Our advisory group works with our clients to assess both the risks that I have just mentioned, and then compares it with any available risk offsets available – from suppliers, exchanges, banks or trading firms. Our trading desk (our subsidiary, Angus Trading) has several new weather-contingent offerings that seek to match ACTUAL volume with the hedges. Part of the reason for one of the offerings is to offset the volumetric risk associated with hedging fixed-price offers.

Irving: We are always working to improve our offerings based on customer requests and feedback. Several items are in the works. One product that is being added this year is wholesale propane out of our new Auburn, Maine rail terminal. This will include the ability for our customers to not only buy LPG spot market gallons but also fixed forward and supply agreement gallons.

Aletheia: PDS (Price Discovery Service): a program designed to compare wholesale rack prices. Biofuels APS Program: a way to profit from biofuel deliveries with a 10% or greater blend.



Aletheia: The trading of derivatives such as futures, options, and swaps may not be suitable for all investors. The risk of loss in hedging or trading commodities can be substantial and Aletheia Consulting Group LLC assumes no liability for the use of any information contained herein. Past performances are not necessarily indicative of future results.

Aletheia Consulting Group LLC is a registered commodity trading advisory firm and a member of the National Futures Association. Mark Skarapas holds a Series 3 Commodity Futures License and Series 30 Branch Manager License.

Angus: Angus Partners, LLC d/b/a Angus Energy is a registered Commodity Trading Advisor (CTA) and a member of the National Futures Association.

PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. The risk of loss in trading commodity interests can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. In considering whether to trade or to authorize someone else to trade for you, you should be aware that you could lose all or substantially all of your investment and may be liable for amounts well above your initial investment.

Hedge Solutions: The information provided in this market update is general market commentary provided solely for educational and informational purposes. The information was obtained from sources believed to be reliable, but we do not guarantee its accuracy. No statement within the update should be construed as a recommendation, solicitation or offer to buy or sell any futures or options on futures or to otherwise provide investment advice. Any use of the information provided in this update is at your own risk.

Sprague: The responses above include forward looking statements that are inherently subjective, and the responses are provided for general information only and are not intended as advice on any transaction nor is it a solicitation to buy or sell commodities. Sprague makes no representations or warranties with respect to the contents of such information, including, without limitation, its accuracy or completeness.

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