Winter is Coming. Shore Up Your Supplies

by Rich Larkin, Hedge Solutions

Get your supply contracts set, and look at last year’s actuals

Winter is coming! The Game of Thrones parlance that produced this idiom has always amused me, primarily from wishful thinking. I mean, what was the latest year that produced a whopping heating season that racked up degree days in a way that could be compared to GOT?

Regardless, here are some random thoughts and pointers to prepare you for the upcoming heating season.

Supply Outlook – How Are The Inventory Levels Looking Heading Into Winter?

How are inventories looking? Total U.S. Distillate stockpiles are below the 5-year average and above last year by almost the same amount (chart 1). More importantly to those of us in the heating oil business, we see PADD 1 (East Coast) stocks in the same position (chart 2). Stocks are still well below the 5-year average but above last year’s levels to the same degree. There is some good news here. Stocks have been increasing almost weekly since the middle of May. It is likely this will continue as export economics are weak at the moment. We are starting to see the impact of stock builds in the forward curve of ULSD futures contracts which have recently progressed to a contango structure; albeit a bit tentative right now. Still, better than the steep backwardation structure that has persisted over the past several years. Why is that a good thing? A contango market makes it easier for suppliers to build stocks into the oil terminals. Robust inventory levels help keep the prices down.

Implied demand for distillates is looking a bit anemic (chart 3). This is likely coming from the manufacturing and transportation sectors. Does it perhaps forebode a weak undertone to the economy? This would also contribute to a weaker pricing regime.

Meanwhile U.S. crude production continues to operate well above 5-year levels outright (chart 4), defying earlier predictions of the inevitable downturn due to weak margins. Remarkably, crude oil producers seem to find methods to get more “blood out of the stone;” raising oil production despite a depleting operating rig count.

Improving inventory levels, robust production, declining demand. Does this mean we will enjoy low heating oil prices this winter? Perhaps. But of course, there are other factors well beyond our control. Geopolitics is once again in the headlines. Will the Middle East volcanic undertone erupt? And then there’s the weather. We have yet to make it through the peak hurricane season that runs through September and into October. The record gulf water temperatures are waiting to feed energy into the “forecasted” parade of tropical storms making their way across the Atlantic.

Supply Contracts

Admittedly, I have likely worn out the discussion around supply contracts. At the risk of redundancy, I would encourage you all to have a look. Even if it’s just a look. These supply agreements have consistently outperformed the rack markets since I first advocated for them 15 years ago. Given the declining count in both the number of suppliers selling ULSHO in the Northeast markets as well as terminal and storage capacity, it makes sense that these contracts are performing so well. If and when we once again enjoy a cold winter, however that gets defined these days, we will see the local basis inflate and that’s where these contracts perform best, giving you both a price advantage as well as a firm commitment from your supplier.

Hedge Review

Finally, I highly recommend a prewinter review of your hedging programs.

Some red flags to look out for: With the warmer winters, and hence lower consumer consumption, the tendency is to underestimate usage which leads you to end up light on your hedges. Higher oil prices while under hedging will lead to smaller, maybe even detrimental, margins. When advising clients, we ask them to retrieve what we call Actuals data. The data, pulled from their back-office system, shows how many gallons were actually delivered to the customers participating in the price protection each month. We can then compare how many gallons were delivered versus what was forecasted each month. This information is invaluable, especially when you have several years of data as it will most likely reshape the delivery curve and hence how you hedge. This data is easy to retrieve from most back-office software systems like Blue Cow, Cargas, ADD Systems, etc. The other important information that emerges from the data is the actual margins attained versus planned. In Hedge Insite, our proprietary software, we organize this data and store it for both monthly and yearly comparisons.

Rich Larkin is President of risk management consultancy Hedge Solutions. He can be reached at rlarkin@hedgesolutions.com or 800-709-2949. www.hedgesolutions.com.

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.

Related Posts