Pirinc: Natural gas supply problems affect distillate, gasoline markets


By the OGJ Online Staff

HOUSTON, July 13 -- US natural gas supply problems contributed to high distillate prices last winter and high prices for gasoline this spring, said a report from the New York City-based Petroleum Industry Research Foundation Inc. (Pirinc).

The report, "It's All Connected: Natural Gas, Electricity, Heating Oil, and Gasoline," considers the complex linkages between markets. It said that natural gas supply problems contributed to oil use by power generators and affected supplies of oxygenates for gasoline.

"Of course crude prices have played a role in the higher costs of oil products, but lately the cost of crude has been averaging about $6/bbl below its November 2000 peak and about the same as a year ago. Thus other factors besides crude prices must be considered analyzing product prices," said the report.

In the end, said Pirinc, market forces triumphed, but not without some "very expensive" help, like economic slowdown in the US and growth slowdowns elsewhere.

Energy policy has a major role in determining how hard market forces must work to overcome potential supply/demand imbalances, it said.

Gas supply and demand
Pirinc said US demand for natural gas has risen faster than supply from domestic production and imports. Demand rose by about 2.5 tcf in the 1998-2000 period, while production and net imports rose by 1.2 tcf.

The difference, said the report, was made up by drawdowns from storage. At the end of 2000, gas in underground storage was down by 800 bcf from its end-1999 level, and 30% below its average end-of-year level for the decade.

"As last year's winter heating season approached, the combination of demand outpacing production and imports, plus extraordinarily low levels of gas in storage had predictable, dramatic effects on natural gas prices nationwide," said the report.

High prices generally depress demand. Why did natural gas show such growth, even though prices leaped?

Competing fuels
Pirinc said the answer to the puzzle was that prices for the most relevant competing fuels, fuel oil and distillate, were rising even faster.

"In early 1999, the fuel oil price was about the same (per MMbtu) as the Henry Hub gas price," said the report. "West Texas Intermediate crude was about 25¢/MMbtu higher, and distillate was about 50¢ higher."

In March of that year, the Organization or Petroleum Exporting Countries and other producers approved a production cut that underpinned a continuous series of oil price increases that did not end until the fall of 2000. Through May of 2000, said the report, rising crude prices pulled the price of fuel oil "significantly" above gas prices.

Fuel oil prices moved more or less in parity with gas prices until November, when oil prices fell as gas prices spiked.

In December 2000 and January 2001, the New York barge distillate price was below the Henry Hub price; in February and March, they were about the same; and since then Henry Hub gas has been clearly cheaper, said the report.

Effect on electricity prices
"While oil's role in power generation has tended to be relatively modest, the extreme increases in natural gas prices have led to a surge in oil use," said Pirinc.

Oil use in power generation -- usually fuel oil and distillate -- was well below 1999 levels through much of 2000. "But beginning in late summer, as prices for natural gas moved first above fuel oil prices and later distillate, oil use surged," said the report.

By the end of the year and in early 2001, oil-fired power generation was running at well over double its levels a year earlier.

Fuel oil use surged at the turn of the year, with December 2000 volume approaching 700 million b/d, up from 200 the year before. In January, fuel oil use reached nearly 750 million b/d, up nearly 400 million b/d from January 2000.

In December 2000, distillate use in power generation reached 275 million b/d as opposed to less than 40 the year earlier. About the same level was reached in January 2001, versus a January 2000 level of about 75 million b/d.

Demand for distillate in particular was a huge leap. Whereas in December 1999 distillate volume for power use was about 1%, in December 2000 it was 7%, and 6% the month after.

"Anticipation of higher demands from the sector as well as other industrial gas users, plus a low distillate inventory starting point, helped prop up distillate prices well before the start of last winter's heating season," concluded Pirinc.

Effect on gasoline
When refineries increased their distillate production to meet demand, some of that came at the expense of gasoline production. The average yield of gasoline over December 2000 through March 2001 was down more than 1 percentage point.

Extreme prices for natural gas also reduced its use as a feedstock for production of oxygenate and octane booster methyl tertiary butyl ether.

Cumulative MTBE production during the period was about 5 million bbl below prior year levels. Those barrels were absent from gasoline inventories at the beginning of the spring.

"While the exceptionally low end-March level of stocks and lingering problems of producing the new Phase 2 gasoline, contributed to this year's price movements, the new factor in the early months of the year was the limited supplies of MTBE, the oxygenate in most of the country's supplies of reformulated gasoline," said Pirinc.

It added that in April and May, production of MTBE is running at approximately year-earlier levels.

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