Robert J. Beck
Economics Editor
Substantially higher prices for distillate and residual fuel oil will dampen U.S. demand for those fuels this winter.
That will more than offset an expected boost in demand as a result of a return to normal winter weather.
Natural gas demand will rise because as some industrial and utility plants switch from distillate and resid to cheaper fuels.
In fact, gas demand will be up in all sectors of the U.S. economy. The sharpest increase will be in electric utilities. Many power plants have multifuel capacity and are able to switch to the lowest cost fuel source.
Slower economic growth-possibly a recession-will tend to slow growth in demand for winter fuels.
The Middle East standoff has spawned jitters about crude oil supply during the winter. Data on worldwide crude oil demand and supply point to a very tight market this winter. If crude shortages develop, they will be reflected in sharp increases in prices.
REFINING PATTERN
In the past few winters U.S. refiners relied on spare processing capacity and increased product imports to meet the seasonal surge in demand. Stocks have played a reduced role in winter fuel supply.
This operating pattern will not change completely this year, but stocks will play a somewhat more significant role.
Low oil prices early in the year, along with excess production by members of the Organization of Petroleum Exporting Countries allowed refiners to build stocks of crude oil and products. Therefore, entering the heating season this year, stocks are higher than they have been in several years.
With all of the uncertainty in the worldwide crude market and facing increased winter product demand, refiners have been reluctant to reduce stocks. But if supplies appear secure as the heating season wears on, refiners will draw down those stocks and release them into the market.
U.S. crude oil stocks at the end of last September were 352.8 million bbl, up 5% from 336 million bbl at the same time last year. American Petroleum Institute figures show U.S. refiners have reduced crude stocks to 339.5 million bbl the week ending Oct. 26.
API lists average operable U.S. refining capacity for last September at 15.516 million b/d, down from 15.722 million b/d at the same time a year ago. Average input to distillation units was 14.33 million b/d, resulting in a utilization rate of 92.4%.
Throughput fell in October. For the week ending Oct. 26 input to distillation units dropped to 12.868 million b/d, and utilization rate was down to 82.5% in a seasonal pattern. That left excess capacity of 2.7 million b/d that could be used to meet an increase in product demand.
Economic growth will be very slow this winter. Real gross national product is expected to be up only 0.4% from last winter's level.
SELECTED HIGHLIGHTS
Here are some highlights of Oil & Gas Journal's outlook for this winter's U.S. fuel supply/demand:
Combined domestic consumption of distillate and resid will be down 2.4%, averaging 4.66 million b/d.
Total demand, including exports, will average 4.97 million b/d, down 2.8% from winter a year ago. Exports will average 310,000 b/d, down from 337,000 b/d last year.
Total fuel oil imports will be off 6.5%, failing along with demand. Imports will average 875,000 b/d, compared with 936,000 b/d last winter.
Distillate supply from stocks will be up sharply, increasing 43.4% to 185,000 b/d, up from 129,000 b/d last winter. Stock levels were higher entering the winter heating season this year and are expected to provide a greater share of supply.
Demand for natural gas will advance 2.1% this winter to 10.9 tcf.
WINTER FUEL PRICES
One of the major factors influencing demand for fuels this winter is the sharp rise in crude oil and petroleum product prices. Prices will remain high throughout the winter if the Middle East dispute is not settled.
Energy Information Administration data show the average price of world export crude slipped to $13.41/bbl at the end of last June from $19.93/bbl the first week of last January.
After Iraq's Aug. 2 blitz of Kuwait and the ensuing embargo of oil shipments from Iraq and Kuwait the price shot up to $36.11/bbl at the end of September. The last data available, for the week ending Oct. 19, show the average export crude price at $33.94/bbl.
There is a sharp contrast in the prices at the start of the heating season in past winters. The price at the start of the winter heating season this year, for example, is up 219.3% from the same time in 1988 and up 119.8% from the same time last year.
The price of heating oils is also up sharply, but the percent.age increase is not as great as for crude oil. EIA data for the week of Oct. 19 show the spot price of No. 2 heating oil-the New York Harbor reseller barge price was $40.05/bbl, up 60.3% from $24.99/bbl a year earlier. The resid spot price was $26.25/bbl, up 47.9% from $17.75/bbl a year earlier.
Substantially higher prices for heating oil will rein demand. Conservation will increase as consumers become more aware of the cost of heating. And it will be harder for resid to compete with natural gas and coal in the industrial and utility markets.
With increased demand, natural gas prices will advance again this winter. Spot gas prices have been showing this seasonal pattern the last several years, with prices moving up sharply during the winter.
The estimated October spot price for natural gas averaged $1.52/Mcf, up only 4.8% from October a year ago. Compared with the price increase for fuel oil, natural gas is a real bargain.
STOCK LEVELS
U.S. stocks of products and crude oil were generally higher at the start of the heating season-the end of September-than they were the past few years.
Distillate stocks this year were 134.2 million bbl, 8.9% or 11 million bbl higher then they were a year ago. Even though demand is expected to be slightly lower, stocks going into the heating season are higher than the past three winters.
This winter's stock level amounts to 40.2 days of expected distillate demand, up from 36.9 days last winter.
The seasonal demand swings aren't as great as in the past and the industry tends to operate with lower initial winter stock levels. During 1974-1983, end September distillate stocks averaged 61 days of winter demand.
With increased refining efficiency and flexibility and adequate crude stocks, refiners are able to operate with slimmer winter fuel stocks.
Distillate stocks will provide 185,000 b/d of supply this winter, or 5.4% of the total. Last winter, stocks provided only 129,000 b/d, or 3.8% of the total.
Distillate stocks are expected to be drawn down to about 100 million bbl at the end of this winter's heating season, which will occur at the end of March 1991.
The National Petroleum Council, in its study of U.S. petroleum storage and transportation, placed the minimum operating inventory for distillate at 85 million bbl. Under the NPC definition, inventory of less than that volume would cause operating problems and shortages.
It is not expected that stocks will have to be drawn down close to the minimum level. However, if supply problems arise there would be a small stock buffer that could be used.
Resid stocks at the start of the winter season were 51.1 million bbl, up 3.4% from the level last year and up 14.6% from the start of the 1988-89 winter. Resid stocks represent about 38.6 days of expected demand, compared with 34.5 days last year and 28.2 days the year before.
Supply from resid stocks will represent only a small portion of total resid supply: 1.7%, or 25,000 b/d. Last winter's stock drawdown averaged only 18,000 b/d, or 1.1% of total supply.
The minimum operating level for resid stocks is 30 million bbl, so there does not appear to be a threat of stocks being drawn down to a level that would cause operating problems.
During the past several years, U.S. refiners have tended to maintain higher crude stock levels. With some excess refining capacity they had the flexibility to process crude and produce heating oil as demand dictated.
At the start of the heating season this year crude stocks were 352.8 million bbl, up 16.8 million bbl or 5% above a year ago.
Excess refining capacity has been trimmed by a reduction in total capacity and increased crude runs to meet greater demand.
API pegs average U.S. operable refining capacity for last September at 15.516 million b/d, down 1.3% from the same month of 1989. Utilization rate for September was a lofty 92.4%, compared with 88.4% in the same month last year.
Latest API figures for the week ending Oct. 26 showed refining capacity up at 15.591 million b/d and utilization rate down at 82.5%. So there is some leeway for increased runs if there is a spurt in demand.
DISTILLATE DEMAND
A return to more normal winter weather this year will give a boost to distillate demand. However, this will be more than offset by price-induced conservation and fuel switching and by the slower rate of economic growth. The result will be a slight decline to an average 3.335 million b/d.
Winter distillate demand has been moving up steadily since the recent low in the winter of 1982-83 at 2.739 million b/d. Steady economic growth and relatively low prices have stimulated demand in the past several years. Domestic demand slipped 0.3% last winter, but that was due to an extremely warm last half of the heating season.
U.S. distillate demand peaked in the winter of 1976-77 at 4.111 million b/d, then fell for 6 straight years, declining 1.372 million b/d or 33.4%. The drop was due mainly to conservation and fuel switching brought on by rapid increases in price. The average price of U.S. No. 2 heating oil jumped to $1.247/gal in 1981 from 41.8/gal in 1976.
The price dropped steadily to 1987, falling to 80.3/gal and stimulating demand. Prices moved up marginally since 1987 and averaged 90/gal in 1989. As a result, demand last winter was up 603,000 b/d, or 22% from the 1982-83 low. The gain in demand of 603,000 b/d recaptured 44% of the earlier loss.
During the past several years lower prices tended to reduce conservation in the residential and commercial sectors of the economy. The low prices also slowed conversions to natural gas or electric heat in those sectors.
The sharp jump in prices this year is expected to revive some of the conservation effort and stimulate fuel switching. However, in the residential and commercial sectors there is not a great deal of dual fuel capability, and switching is more of a longer term phenomenon.
Steady economic growth since 1982 has sparked distillate demand for transportation. The transport fleet using diesel fuel has increased at a faster pace than the improvement in fleet fuel efficiency. Slower economic growth this winter will slow the increase in transport demand for diesel fuel.
Higher prices, increased conservation, slower economic growth, and increased fuel switching will all work against increased demand for distillate this winter. This will be offset by increased demand due to closer to normal weather.
Refinery production of distillate will be down 2.1% this year at 2.905 million b/d. Imports will be near the level of a year ago at 335,000 b/d.
A larger contribution from stocks will make up for the lower refinery output and slightly reduced level of imports. Supply from distillate stocks will be 185,000 b/d this year, up from 129,000 b/d last year.
Refiners entered the winter heating season with higher distillate stocks than in the past few years. Falling oil prices during first half 1990 encouraged refiners to boost stock levels earlier in the year.
Historically, U.S. distillate stocks are highest in October and lowest in April-about 30-40% below the peak.
Last winter, stocks were at 123 million b/d at the end of September and fell to 99 million b/d at end April, a drop of 20%.
Stocks were low entering the winter heating season last year. But warmer weather reduced demand, and refiners boosted production to make up for the lower stock level.
Stocks were at 134 million b/d at end September this year and will be able to make a greater contribution to supply without causing operating problems.
API figures show distillate stocks had moved up to 138.1 million b/d for the week ending last Oct. 26. Because of uncertainty surrounding the crude market, refiners have not started to reduce product stock levels.
RESIDUAL DEMAND
Higher prices and the resulting fuel switching will have a greater effect on demand for residual fuel oil.
Demand is expected to fall 7.5% to 1.325 million b/d this winter. Demand last year was 1.433 million b/d, down 9.3% from the winter of 1988-89.
Prices last winter were up nearly 50% from the previous winter.
Demand for resid is more sensitive to price because many industrial plants and utilities that use resid can switch to other less expensive fuels, mainly natural gas.
Electric utility demand for heavy fuel oil jumped 36.1% in 1986 to 592,000 b/d when prices fell sharply. Resid demand fell 14.9% in 1987 to 504,000 b/d when prices rebounded.
Demand increased again with lower prices in 1988, moving up 24.5% to 627,000 b/d. Low prices at the start of 1989 and extremely cold weather at the end of the year helped boost demand 5.4% to 661,000 b/d, even though the average price for the year moved up.
Lower electrical power output from nuclear plants earlier in the year also helped boost utility resid demand in 1989.
A substantial portion of resid supply is from imports. The situation in the Middle East adds some uncertainty to all imported supply.
Imports are expected to be down this year due to reduced demand, falling 9.7% to 540,000 b/d.
Imports last winter averaged 598,000 b/d and the winter before were up to 808,000 b/d.
Refinery output is also expected to be lower this winter-down 7.8% to 980,000 b/d. Lower refining capacity also contributes somewhat to the expected lower resid output. However, there does appear to be some capacity cushion in case imported supply becomes a problem.
Resid stocks were higher at the start of the heating season-up 3.4% at 51.1 million bbl. Stock withdrawals are expected to contribute 25,000 b/d to supply this winter, compared with 18,000 b/d last year.
NATURAL GAS
Electric utility demand for natural gas will advance 6% to 1.13 tcf this winter. This follows a 7.1% increase last winter to 1.066 tcf.
Utility demand for natural gas will get a boost from increased use of electrical power for heating and the switch to natural gas from heavy fuel oil because of cost considerations.
Last year natural gas demand was also boosted by movement away from heavy fuel oil in the utility sector. The growth in electrical power from nuclear plants has slowed, and this also contributes to growth in utility demand for natural gas.
The sharp rise in the cost of heavy fuel oil will substantially reduce competition from this fuel source.
During May-October 1986 heavy fuel oil costs for the first time fell below gas costs for electric utilities. Before that period, heavy fuel oil had consistently been the most expensive fuel for power plants and well above natural gas costs.
For all of 1986 heavy fuel oil cost power plants $2.401/MMBTU, only 2.4% more than gas. In 1987 heavy fuel oil was 33.2% more costly than gas, but that spread slipped to 6.1% in 1988. The comparison increased to 20.8% last year with heavy oil at $2.846/MMBTU and natural gas at $2.355/MMBTU.
With the sharp rise in crude and resid costs this price difference has increased substantially.
The increase in demand in other sectors will be more a result of colder weather this year than of economic growth. Last winter the weather in the second half of the heating season was very warm and substantially reduced the demand for fuels for heating.
Economic growth is expected to be very sluggish during the two quarters that make up the winter heating season. There are even some projections of a recession over the next few quarters.
Industrial demand for natural gas will move up 0.9% to 3.56 tcf this winter. Demand last winter increased 3.4% to 3.527 tcf.
Residential demand this winter will be up 2% at 3.45 tcf. Demand fell 0.3% last year.
Commercial demand is expected to be up 1.5% at 1.83 tcf. Sluggish economic activity will somewhat offset the boost from more normal winter weather.
Gas has been making some progress capturing the fuel market in the commercial and residential sectors. There also has been some growth in the industrial sector, where there is more fuel switching capacity and growth depends on relative fuel costs.
Gas remains largely a swing fuel in the electric utility sector. However, there are some strong indications that demand may move up in this sector.
The growth of power output from nuclear power is slowing, and power from this fuel is expected to reach a peak in another couple of years.
In addition, there are environmental problems in trying to increase the capacity of coal fueled facilities. With the expected growth in electrical power demand, this leaves a gap for natural gas to fill.
Copyright 1990 Oil & Gas Journal. All Rights Reserved.