Behind the winter of our discontent

When the first cold snap hit, Americans turned up their thermostats and then, gawking at their fuel bills, turned them back down again.

Small wonder. Fuel-oil prices are at a 10-year high. Natural-gas prices have tripled in the past few months. Crude-oil prices have fallen recently, but they are still nearly twice what they were a year ago.

Turn on the television, and some sparky young market analyst will likely blame the current fuel prices on "low inventories." Racing on to pork bellies and dotcoms, without pausing to explain what low inventories actually are, Sparky will leave much of America grasping for a metaphor.

Has the industry, like some giant squirrel that neglected to store up acorns for the winter, simply forgotten that customers need more fuel when it's cold? The short answer is no, but a longer explanation may be in order

Be the squirrel

To understand the mind-set of the companies that affect the supply of fuel, and thus, your fuel bill, it pays to know the squirrel in charge of gathering nuts for the winter.

Here in the US and in most industrial nations, the people who ultimately control the supply of gasoline at the pump, or heating oil in the truck, are a small, bright, tight-lipped group of risk-takers known as commodities traders. Some work for the dozens of refineries that cluster near urban areas along the West, East, and Gulf Coasts. Others work for special commodity firms on Wall Street or at the Chicago Board of Trade. All buy and sell oil on the futures market, making multimillion-dollar guesses on where the price of oil will be one month, six months, or up to two years from now.

"The commodity trader, that's where this whole thing comes together," says Jim Steel, director of market research for Refco, a New York-based hedge fund. "What he wants is very, very low crude-oil prices and very high gasoline prices.... It's like a furniture maker. He wants cheap wood, but expensive furniture."

In an incredibly competitive market, where customers can drive past a dozen gas stations in search of the cheapest price, brokers must pick their purchases carefully. After all, if Exxon bought oil when prices were $36 a barrel, and Texaco bought at $12 a barrel, Exxon won't be able to charge three times more at the pump. Customers will just switch to Texaco. Gas is gas.

Gas is gas, isn't it?

The incoming Bush administration is likely to take a different tack on energy than the Clinton White House did. Some experts say President-elect Bush, a former oilman, will push for a more standard formula for gasoline, so that the same gas sold in Las Vegas can be sold in Chicago.

"If you were building a house in Austin, and you ran out of nails, you could go to San Antonio and buy them there," says Adam Sieminski, market analyst for Deutche Bank Alex Brown in Baltimore. "But if Chicago runs out of gasoline, you can't go to Fort Wayne and get gas to bring back and sell. It's a different formula."

"We are likely to see under [Bush] more sensitivity to industrial realities," he adds.

On energy policy, he is likely to be as different from President Clinton as President Reagan was from President Carter. Mr. Bush might not have created a heating-oil reserve, as Clinton did this summer, arguing that Washington should let the free market balance out levels of supply and demand. And Bush would have avoided tapping the Strategic Petroleum Reserve, which Clinton opened this summer to ease gasoline prices, since the SPR was created for national emergencies.

That doesn't mean Bush will be every oilman's dream. His paper-thin victory means he is unlikely to open up Alaska's Arctic National Wildlife Refuge to drilling.

Tool time

To help make decisions on when to buy, commodities brokers have a few, imperfect tools. The most prominent of these is "The Forward Price Curve." Open the financial pages of your local newspaper, and you'll find out what it costs to buy a contract for oil up to two years from now. Put those numbers on a graph, and you can see the direction in which those prices are heading, at least for now. Keep in mind that those prices change every day.

Looking at that curve, most brokers are currently sitting on their wallets.

This might seem odd, given America's low inventories. The reason is simple. Oil prices are now dropping rapidly, both because of an expected economic slowdown and because of a growing global supply. The price of a barrel of West Texas Intermediate to be delivered in January is $28. That same January contract, bought a week ago, would have cost $31.

"There's been no incentive to build inventory," says Marianne Koh, chief economist for Texaco in White Plains, N.Y. "Not only do you lose money by buying oil and holding it in your tanks, but you will have to sell the product for lower prices later."

Economists have a five-dollar word for this situation: "backwardation." Essentially, it's like waiting to buy shoes at Talbots until after Christmas, when the holiday clearance sale begins.

The difference, of course, is that Talbots' Christmas sale falls on a predictable date. Oil prices rise and fall daily. And oil is perhaps a more important commodity than, say, a nice pair of flats.

For the winter of 2000-2001, this backwardation means that motorists will be stuck with current gasoline prices and many homeowners will need to break out their long johns.

Shopping way ahead of time

With a disincentive to raise the price of their product, oil companies are under increasing pressure to make their money at the volatile front end of the market, where future contracts are bought and sold.

Any blip in the news can cost a company billions and lose a commodity broker her Christmas bonus. A projected slowdown in the economy, for instance, or forecasts of a warm winter, can make prices drop. A threatened embargo by Iraq or a mechanical breakdown at a refinery in Louisiana can make prices soar.

"It must be very difficult to be in charge of a refinery," says Mr. Steel of Refco.

"On one hand, the American public has an insatiable thirst for gasoline. I mean, people drive tanks these days, don't they? On the other hand, nobody wants you to build a refinery in their backyard. We haven't built a refinery in this country in almost 10 years."

Suggestion box

In time, energy experts say, the price of oil will gravitate back to a more comfortable norm of $15 to $25 a barrel.

But as long as prices fluctuate beyond that comfort zone, there will be calls for reform to protect customers from volatile price shocks.

During the summer, for instance, when the price of gasoline shot above $2 a gallon in Illinois and California, there were calls for a congressional investigation of possible price-gouging by the oil industry.

Summertime is generally when oil refineries produce both gasoline and heating oil for the coming winter. But with the public outcry for more gasoline, most refineries put their energy into producing that. This brought the price down, but has led to the nation's current shortage of heating oil.

Washington's intervention in the oil market is not restricted to mere investigations. This year, the federal government set up a heating-oil reserve of some 2 million barrels, the equivalent of some seven to 10 days of supply. The reserve is particularly popular in the Northeast, where 75 percent of the nation's 100 million barrels a year are consumed.

Oil-industry insiders take a darker view, calling this reserve an unwanted intrusion in an already-volatile market.

(c) Copyright 2000. The Christian Science Publishing Society

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