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Bioheat distribution has grown in the last year. We look at what retailers and wholesalers are doing to meet your growing demand.
Energy prices are working against Oilheat dealers again this year. Last year, it was a price drop that wreaked havoc with fixed price programs. This year it is record-high prices that are squeezing customers' budgets and tempting them to look around for alternatives. Who knows what next year will bring?
No one knows for sure, but one group that is constantly digging for informed answers is the Energy Policy Research Foundation, Inc. (EPRINC). The Washington, D.C.-based organization formerly known as the Petroleum Industry Research Foundation, Inc. (PIRINC) studies energy economics with special emphasis on oil and distributes its findings via analytical reports and media commentary. EPRINC is supported by approximately 35 oil companies, but the views it expresses are its own and do not represent the oil companies.
Lucian (Lou) Pugliaresi has been president of EPRINC since February 2007, having previously served on the Board of Trustees. He previously worked as a consultant and has held positions with the National Security Council, the Departments of State, Energy and Interior, and the Environmental Protection Agency. His writings have appeared in Oil and Gas Journal and other industry journals. He recently fielded questions from Oil & Energy.
How does the weakening of the U.S. dollar affect the oil markets?
I am not sure anyone knows the answer to this question since there are so many moving parts, including capital flows, OPEC pricing behavior, shifts in terms of trade, and U.S. monetary policy. It is also quite difficult to solve what is called the "identification problem," i.e., was it rising oil prices that had some impact on the terms of trade that shifted the supply and demand for dollars, or did some other policy initiative (expanding the money supply, cheaper credit, etc.) cause the dollar to fall, thereby making imports (including oil) more expensive. For your readers who want to wade into this issue there are plenty of obscure journals on monetary policy they could read.
On a more serious note, the U.S. has historically benefited by the willingness of foreigners to hang on to dollars as a store of value. Ultimately the dollar is backed up by the productivity and goods and services produced by the U.S. economy. In this regard, we may be seeing some short-term shifts out of the dollar, but given the size and productivity of the U.S. economy I don't see a sustained move away from the dollar.
Remember even today, the U.S. with 5 percent of the world's population produces 21 percent of the world's manufactured goods. The U.S. also remains a safe haven for investors in times of turmoil, and so I would expect the dollar to remain the world's reserve currency.
As an aside, there are some indicators that the dollar is close to if not at the bottom of its valuation and may be headed back up, but it will take time.
This still leaves us with the question of what has driven up the price of oil. I think the forces at play in the market now are more short- and medium-term, than tied to concerns over peak oil or concerns that ultimate recovery of conventional crude resources is declining rapidly.
If you go back to 2003, you can point to several regions in the world where we would reasonably have expected output to expand or at least not experience any kind of dramatic decline. As 2003 to 2004 played out we had war in Iraq, growing rebel activity in Nigeria disrupting operations, Chavez taking over in Venezuela substantially harming PDVSA's existing and future operations, the Russians practicing their own version of resource nationalism, and several projects around the world experiencing delays due to technical problems. And we faced some severe shortages of steel and expertise in the oil service sector. You add all this up, and it is fairly easy to make the case the world oil market lost between 2.5 million and 3 million barrels/day of production that prior to 2003 we were confident would be available.
This kind of shift in expectations on the availability of wet barrels places a heavy toll on the market and given lead times for bringing on new supplies will take time and effort to make up. So I don't see the current run-up in prices as some kind fundamental supply crisis given new supplies scheduled to come on line starting in 2008-10. Looking beyond that time, say after 2015, it's really strictly a guessing game.
Regarding the near term, I would expect to see some downward pressure on crude prices in the next couple of years, even given rising demand in China and India. Some of the bottlenecks on the upstream side are getting worked out and the high prices are in fact resulting in adjustments on the demand side.
Iran and Venezuela are pushing for Euro pricing of oil. What will come of that?
Iran and Venezuela are free to post prices for their crude in any currency they wish, but the rest of the world will continue to use dollars as long as it remains the world’s reserve currency. The Iranians, in fact, recently announced that they will sell their crude in Yen and Euros. Currency markets are arbitraged every minute of every day, so I think the net effect is that they are hedging on the currency markets, but I doubt this is the most efficient strategy for dealing with currency risk, and so I suspect they will suffer some modest financial penalties using this strategy. With regard to the Euro, it has gained considerable interest, and can play a role as a secondary reserve currency, but there are limits to its role as a replacement for the dollar.
How would a switch to Euros affect markets globally and in the U.S.?
The switch away to Euros or any currency as the world's reserve currency would only occur over a very long period of time. Should this occur, which in my opinion is highly unlikely, I suspect the U.S. would suffer a one-time and somewhat dramatic shift in the terms of trade. But I don't think this is in the cards.
A substantial gap has developed between the prices for heating oil and natural gas. Why has the price of distillates increased?
The answer to this question has to first start with what has been happening in the downstream market in the U.S. and Europe. Since 2002, world demand for the middle of the barrel has increased twice as fast as demand for gasoline.
This has led to what we believe is a somewhat unbalanced product market (and probably not sustainable over the very long-term) where the middle of the barrel (distillates) are priced higher than gasoline. From a pure production cost outlook, distillate should be cheaper than gasoline. We are not getting the historic relationship in pricing between the middle of the barrel and gasoline because the Europeans and other world refining centers are running full tilt to meet distillate demand, which is also yielding substantial volumes of gasoline components in excess of local demand. These gasoline components are then sold into the U.S. market.
Note that we at EPRINC don't view distillate as selling at a premium to gasoline, but gasoline being discounted to distillate. Of course, both statements are accurate, but how you look at this problem is important for understanding how the market is likely to shift over time. Over time we would expect the Europeans to reconfigure their refineries to reduce gasoline, and increase distillate output, but this will require substantial capital outlays. This is one reason why the price spread between natural gas and heating oil has opened up so much over the last few years.
Why has the price of natural gas been more stable?
Among many analysts there is a fundamental disagreement on what will be the driving factors in determining the price of natural gas in the U.S. market. On the supply side, we have to look to the production outlook from Canada, the pace of discoveries as well as the expansion of new fields in the U.S. (both onshore and offshore), the timing of Alaskan gas deliveries to the lower 48, and finally volume and pricing of LNG imports. Here we face considerable uncertainly on the supply side, both in terms of volume and price.
The other issue is what is the appropriate competitive fuel for gas. In the absence of a highly integrated and fungible gas market (including a high volume of spot LNG cargos), the North American market can be viewed as sufficiently disconnected at the point where all users who can shift out of oil or refined products have done so. Are we already at the point? I am not so sure, but clearly we are close to the point where most consumers who can shift out of oil--at least in the medium term--have done so. So then we have the case where gas tends to compete either head-to-head with higher-cost gas supplies, or in some cases against coal supplies for the utility sector.
EPRINC is starting to look at this issue in some detail, and we don't have a definite view yet, but we can point to some developments in the market that suggest that the current gap between oil and gas is too large to be sustainable. We can certainly see a scenario where a combination of rising gas demand, refinery upgrades and expansions, and international gas trade will bring the valuations much closer together.
Heating oil prices increased by 35 percent between August and November of 2007, and we did not see a repeat of last year's price collapse. Why has this year played out differently from last year?
First, there is still plenty of time for adjustments in the market this heating oil season. Nevertheless, we are likely to see heating oil bills higher this year as compared to 2006-07 winter. EIA is now forecasting an increase of 10 percent over last year and so far the number of heating degree days also is modestly above last year, with several forecasters looking to a somewhat colder season. Weather will probably be the driving variable, but recall my earlier discussion: heating oil is competing for the middle of the barrel on a worldwide basis. We may get some relief if crude prices erode further and refining operations remain at very high levels of availability (with few unscheduled maintenance problems), but there are a lot of wild cards, from Iran to Nigeria, still hanging over the market.
Low-sulfur heating oil will likely be mandated in Northeastern states within a few years. How would that development affect supply and price?
Many heating oil marketers have been looking to very low sulfur products as an opportunity to market the product as environmentally friendly, or at least an opportunity to give the industry more of a green patina. I'm not sure how valuable these efforts are as a strategy to maintain industry's market share.
There are two additional issues to sort through. First, what environmental standard makes sense for the heating oil community? There is really no need from an air quality goal to go to a sulfur standard of 15 ppm. I realize even the higher sulfur distillates have been expensive, but as the refining industry produces larger volumes of 15 ppm to meet on-road requirements, I would recommend the heating oil community move at a much slower pace because (1) it really is not necessary in terms of environmental protection, (2) it's costly to make the adjustments in a hurry, and (3) although we haven't seen many opportunities for substantial discounting for higher sulfur supplies, there will be from time to time opportunities to obtain higher sulfur distillate supplies at substantial discounts. For the heating oil industry, this is an option they should preserve as long as possible.
Will distillate consumption continue to grow in India and China at the current rates?
Long-term demand for distillate will be driven by both prices and income. As both of these countries become more prosperous, they will be able to sustain high demand growth. Both countries also have a very low ratio of cars to eligible drivers, so potential future demand remains high. Whether they can maintain historic levels of growth is really not knowable with any precision. A lot of new refining capacity is coming on line in Asia and this will likely work to dampen refining margins, so we'll get some help there in terms of prices. In addition, several countries in both Asia and the Middle East have been subsidizing motor fuel consumption. If prices continue to rise, we will certainly see many of these governments attempting to move away from subsidizing motor fuel consumption, which also offers some opportunities to limit demand growth in the region.
What are your expectations regarding the future of ethanol and biodiesel? Are they viable fuels? Will their use have any effect on distillate and gasoline prices in the long run?
We have done quite a bit of work on ethanol over the last year, but haven’t given much attention to biodiesel. Biodiesel production remains small, and the product is very expensive to manufacture. Before I go through our ethanol analysis, I would like to point out that we are always concerned about making long-term business decisions based on government mandates and subsidies—what the government gives it can also take away.
I suggest your readers visit our website (www.eprinc.org) where they can download several reports on ethanol. Our research to date shows that ethanol is a highly valued commodity as a substitute for MTBE (octane booster), and it can help in some gasoline formulations to meet environmental standards in specific markets.
This is about 5 percent of the gasoline pool, between 6.5 and 8 billion gallons per year. Even in this range ethanol starts to go head-to-head with gasoline, and given that it has 30 percent fewer BTUs than gasoline and is more expensive to handle and distribute, it has to discount substantially to get blended into the gasoline pool, even with the 52 cents a gallon blender’s tax credit.
So far a combination of the blender's credit and market valuations has driven ethanol demand to levels above mandates passed by Congress. But you can see what has been happening to ethanol prices in the last few months as they compete head-to-head with gasoline. Ethanol prices have declined well below $2/gallon which has really cooled the enthusiasm in the investment community for new ethanol plants.
The use mandate will increase under current law and is likely to increase further given recent legislation pending in Congress. Here our concern is that the obligated parties (terminal operators, refineries, and blenders) may face very high distribution costs to get the ethanol distributed throughout the entire gasoline pool and at the same time not offering much relief to the ethanol producers. Ethanol is not oil and we may end up with a train wreck unless Congress revisits the issue down the road.
How severely would the oil markets be affected by continued or more aggressive conflict between the U.S. and Iran?
The risk profile for Iran has improved substantially with the release of the recent National Intelligence Estimate, but turmoil in the Middle East will be with us for some time. Right now it is not the biggest security problem facing the world oil market.
But as we have said many times over the last year, in a market where there is very limited excess upstream production capacity, surprises will get priced.