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- CRB Fundamentals - 2008 Commodity Articles

Heating Oil

Heating oil is a heavy fuel oil that is derived from crude oil. Heating oil is also known as No. 2 fuel oil and accounts for about 25% of the yield from a barrel of crude oil. That is the second largest "cut" after gasoline. The price to consumers of home heating oil is generally comprised of 42% for crude oil, 12% for refining costs, and 46% for marketing and distribution costs (Source: EIA's Petroleum Marketing Monthly, 2001). Generally, a $1 increase in the price of crude oil translates into a 2.5-cent per gallon rise in heating oil. Because of this, heating oil prices are highly correlated with crude oil prices, although heating oil prices are also subject to swift supply and demand shifts due to weather changes or refinery shutdowns.

The primary use for heating oil is for residential heating. In the U.S., approximately 8.1 million households use heating oil as their main heating fuel. Most of the demand for heating oil occurs from October through March. The Northeast region, which includes the New England and the Central Atlantic States, is most reliant on heating oil. This region consumes approximately 70% of U.S. heating oil. However, demand for heating oil has been dropping as households switch to a more convenient heating source like natural gas. In fact, demand for heating oil is down by about 10 billion gallons/year from its peak use in 1976 (Source: American Petroleum Institute).

Refineries produce approximately 85% of U.S. heating oil as part of the "distillate fuel oil" product family, which includes heating oil and diesel fuel. The remainder of U.S. heating oil is imported from Canada, the Virgin Islands, and Venezuela.

Recently, a team of Purdue University researchers developed a way to make home heating oil from a mixture of soybean oil and conventional fuel oil. The oil blend is made by replacing 20% of the fuel oil with soybean oil, potentially saving 1.3 billion gallons of fuel oil per year. This soybean heating oil can be used in conventional furnaces without altering existing equipment. The soybean heating oil is relatively easy to produce and creates no sulfur emissions.

The "crack-spread" is the processing margin earned when refiners buy crude oil and refine it into heating oil and gasoline. The crack-spread ratio commonly used in the industry is the 3-2-1, which involves buying 1 heating oil contract and 2 gasoline futures contracts, and then selling 3 crude oil contracts. As long as the crack spread is positive, it is profitable for refiners to buy crude oil and refine it into products. The NYMEX has a crack-spread calculator on their web site at www.NYMEX.com.

Heating oil futures and options trade at the New York Mercantile Exchange (NYMEX). The heating oil futures contract calls for the delivery of 1,000 barrels of fungible No. 2 heating oil in the New York harbor. In London, gas/oil futures and options are traded on the International Petroleum Exchange (IPE).

Prices - NYMEX heating oil futures prices on the nearest-futures chart started the year 2007 at around $1.57 per gallon and rallied all year, with a brief dip in July-August, to end the year at a record high of about $2.68 per gallon. The rally continued into early 2008.

Supply - U.S. production of distillate fuel oil in 2007 (through June, annualized) fell by -0.2% yr/yr to 4.043 million barrels per day, down from last year's record high of 4.049. Stocks of distillate fuel oil in June 2007 were 124.8 million barrels, up from 123.8 million barrels in June 2006. U.S. production of residual fuel in 2007 (through June, annualized) rose by +3.7% yr/yr to an average of 658,000 barrels per day, which less than half the production levels of well over 1 million barrels per day produced in the 1970s. U.S. stocks of residual fuel oil as of January 2007 rose +13.4% to 43.4 million barrels from 37.4 million barrels a year earlier.

Demand - U.S. usage of distillate fuel oil in 2007 (through June, annualized) rose +2.7% yr/yr to 4.285 million barrels per day, which was a new record high. That figure includes both heating oil and diesel fuel usage.

Trade - U.S. imports of distillate fuel oil in 2007 (through June, annualized) fell -14.7% to an average of 306,000 barrels per day, down from last year's record high of 359,000 barrels per day. U.S. exports of distillate fuel oil in 2007 (through June, annualized) fell by -18.3% yr/yr to an average of 176 barrels per day. U.S. imports of residual fuel oil in 2006 fell -35.1% yr/yr to 344,000 barrels per day, which was less than a third of the levels of over 1 million barrels per day seen back in the 1970s. U.S. exports of residual fuel oil in 2006 rose +12.7% to 283,000 barrels per day, which was a record high.

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