Distillate inventories in the Northeast part of the United States are far below normal levels. As a result, the Energy Information Administration (EIA) is warning that "low distillate inventories could contribute to heating oil price volatility this winter." They forecast that retail heating oil prices in the area will average $0.07 per gallon higher than last year's record average of $3.73 per gallon.
The culprits behind the low inventories are a series of refinery outages, closure of refineries in that area, and to a lesser extent consumers switching from heating oil to natural gas.
The EIA also reported that this year New York lowered the specification for home heating oil to 15 parts per million of sulfur – the same as ultra low sulfur diesel (ULSD). This is significant because it is expected to increase demand of ULSD by as much as 170,000 barrels per day during a sustained cold streak.
Additionally, because ULSD production is much tighter globally than higher sulfur distillate fuels, New Yorkers will pay a premium for their heating oil, and they could see sharp price spikes.
Inventory levels are a good indicator of the direction of prices. If inventories of a particular product are declining – but prices are not rising in response – that can represent a strong buying opportunity. In this case, the opportunity is in heating oil futures.
The January 2013 heating oil contract is trading on the NYMEX at around $3.03 per gallon. This is about where this contract traded at this time last year when inventories were in much better shape.
The risk of course is that if the winter is exceptionally mild, demand will be low and heating oil prices will fall. Likewise, if oil prices decline from current levels, heating oil prices are likely to fall. But the more distillate inventories continue to fall, the greater the opportunity for price appreciation in heating oil futures. So keep a close eye on those inventory levels.
– This article is a modified version of a story in Energy Trends Insider, a free subscriber-only newsletter that identifies and analyzes financial trends in the energy sector. It's published by Consumer Energy Report.