WINTER DEMAND WILL BOLSTER PRICES FOR FUEL OIL IN THE U.S.

Robert J. Beck
Economics Editor

Demand for fuel oil will move up in the U.S. this winter for the third straight year, largely on the strength of lower prices and increased economic activity.

The weather, predicted to be only a little colder than last winter, will make a minor contribution to the demand increase.

Natural gas consumption also will be up again this year. However, substantially higher gas prices will slow the rate of gain. Increased demand from the industrial sector will lead the way, with higher demand also expected from residential and commercial customers.

Those increases will be somewhat offset by slightly lower demand among electric utilities, where demand will slip due to higher prices and fuel switching capability .

Economic recovery, robust but steady, will continue throughout 1994. Gross domestic product will be up 2.4-2.7% this year and grow at a slightly higher rate next year. Industrial production will rise significantly, boosting demand for fuel oil and natural gas.

Petroleum stocks are large enough to meet expected demand this winter. Entering the winter heating season, stocks of distillate and crude oil were up from the levels of a year ago.

However, residual fuel oil stocks were low at a level more consistent with the end of the heating season than the start, and are not expected to contribute to supply. Refiners will rely more heavily on imports to help satisfy resid demand.

The only area of potential concern is refining capacity. It has declined as throughput has risen and utilization rate has moved close to the maximum sustainable level. There is little spare capacity to meet a surge in demand due to colder than expected weather or to make up for refinery accidents or other problems.

Worldwide crude supply is substantial, and there should be no problem in obtaining added feedstock. In fact, the world crude market is currently more concerned with excess production, which is putting downward pressure on prices. So refiners should be able to satisfy crude oil requirements at advantageous costs.

FORECAST HIGHLIGHTS

Here are some of the highlights of Oil & Gas journal's outlook for U.S. winter fuels supply and demand.

Domestic demand for distillate and residual fuel oil will average 4.473 million b/d, up 3.3% from last winter. Total demand, including exports, will average 4.935 million b/d, up 4.6% from a year ago.

Exports will average 462,000 b/d this winter, up 71,000 b/d from last winter. Distillate exports, which fell sharply last winter, will advance 21,000 b/d to 257,000 b/d. Resid exports, which also dropped last year, will rebound by 50,000 b/d to 205,000 b/d. Lower fuel oil prices will boost exports.

Total fuel oil imports will rise 3.7% to 640,000 b/d. Imports of resid fuel o will increase 6.7% to 415,000 b/d. Distillate imports will be close to the level of a year earlier - down 1.3% a 225,000 b/d. Distillate imports have not varied a great deal during the last several years.

U.S. refinery production of fuel oil will increase 5.3% to 4.103 million b/d.

Fuel oil supplied from stocks will be down this winter, mainly because of low stocks when the heating season began. However, total stocks are adequate to meet winter demand.

Stocks will provide 192,000 b/d of fuel oil this winter, compared with 207, 000 b/d last winter and 270, 000 b/d the previous winter.

Distillate stocks at the end of September were 131 million bbl, compared with 128 million bbl last year. Resid stocks were only 41 million bbl this year, compared with 47 million bbl last year, while crude oil stocks were 329 million bbl at the end of September this year vs. only 322 million bbl a year earlier.

Natural gas consumption will rise 1.2% to 11.936 tcf this winter. Demand increased 3.5% last winter to 11.789 tcf. The largest increase will occur in the industrial sector due to improved economic growth.

DISTILLATE

Domestic demand for distillate will rise 3.5% this winter to an average 3.328 million b/d. It will be the third consecutive A,inter to post increased distillate consumption. Distillate demand moved up 2.9% to an average 3.12 million b/d during the 1990-91 winter and increased 3.1% to an average 3.216 million b/d last winter.

Consumption this winter will be stimulated in part by relatively low prices. Excess worldwide production has led to lower crude oil feedstock costs and moderate distillate prices.

U.S. distillate demand peaked in 1976-1977 at 4. 1 11 million b/d, then fell for 6 years in a row, declining 33% to the recent low of 2.739 million b/d. This was a drop of 1.372 million b/d in demand, mainly due to fuel switching and conservation brought on by rapid price increases.

The average price of No. 2 heating oil to residences jumped from 41.8/gal in 1976 to $1.19/gal in 1981. The price then dropped steadily during 1981-87, falling to 80.3/gal in 1987.

Lower prices and steady economic growth helped boost distillate demand, which climbed to 3.353 million b/d in the winter of 1988-89.

An economic recession and warmer than normal weather led to a slump in winter middle distillate demand, which dipped to 3.033 million b/d in 1990-91. Somewhat sluggish but steady economic growth, coupled with a return of closer to normal winter temperatures last year, boosted demand the last two winters. Middle distillate demand moved up 2.9% in the winter of 1991-92 and another 3.1% last winter to 3.216 million b/d.

Weather has had a substantial effect on demand during several recent winters as temperatures have averaged warmer than normal.

The number of heating degree days during the 1989-90 winter was 6.8% below (warmer than) normal. This increased to 10.7% below normal in 1990-91 and 8.9% fewer degree days in 1991-92. Last year the weather was very close to the long run average, and the number of degree days was only 1.2% fewer than normal.

Expectations are that this winter the number of degree days will again be close to the long run average.

Distillate prices moved up, along with higher crude oil costs and increased demand, reaching $1.06/gal in 1990. Prices in 1990 also road the coattails of a surge in crude oil prices due to the Persian Gulf war. Prices have slipped since then and averaged only 93.4/gal last winter.

Weak crude oil prices have led to even lower distillate prices this year. Latest data reported by the Energy Information Administration (EIA) pegs the average residential price for No. 2 home heating at 84/gal last August vs. 88.6/gal in August 1992.

Relatively low prices will discourage cost related conservation on the part of consumers and help boost winter demand.

EIA forecasts an average residential heating oil price of 94.9/gal this winter, the same as last winter. It expects a peak of 96.7/gal next month.

The economic recovery's boost in transport demand for diesel fuel will continue this winter. On-highway transport accounts for about 45% of distillate consumption.

Demand for residential and commercial heating is not expected to rise as sharply. In this sector, distillate is in direct competition with natural gas, which is capturing the majority of new construction. The increased availability of natural gas, particularly in the Northeast, is also leading to some heating unit conversions, lowering demand for distillate.

Residential and commercial sectors account for 21% of U.S. distillate consumption. Demand in other areas such as rail and marine transport also will get a boost from growth in economic activity.

New requirements for low sulfur content in on-highway diesel fuel may trim transport demand due to the expected higher costs. The Clean Air Act amendments of 1990 required that all on-highway diesel fuel contain no more than 0.05 wt % as of last Oct. 1.

EIA expects a 10% rise in diesel fuel prices this winter due to a combination of the new fuel specifications, increased federal taxes, and higher crude prices. Cost of the new fuel specifications is estimated at 3-4/gal, made up of le in variable costs and 230 to recover investment.

It does not appear that crude oil costs will advance this winter. So the diesel price increase projected by EIA may be too high.

Most of the increase in demand will be supplied by increased refinery production of distillate which is projected to move up 3.9% to an average 3.173 million b/d this winter. This will be the highest winter output since 1977-78.

Imports will slip 1.3% to 223,000 b/d.

Imports have played smaller roles in winter distillate supply in recent years. They'll averaged 201,000 b/d in the 1990-91 winter, 233,000 b/d in 1991-92, and 228,000 b/d last winter. The level of imports generally depends on the relative prices of foreign supplies and any surges in demand due to much colder than expected weather.

The supply contribution from prewinter stocks will increase about 10% to 187,000 b/d. Stocks contributed 170,000 b/d of distillate last year and 233,000 b/d the year before.

U.S. refiners entered this year's winter heating season with distillate stocks at 131 million bbl, up slightly from 127.8 million b/d at the start of last year's heating season.

Stocks represent 39.4 dan,s of expected demand this winter. Last yearend September stocks were 39.7 days of winter demand.

During the last four winters refiners have drawn down distillate stocks to 97-98 million bbl by the end of the heating season. The remaining stocks are required to sustain the system.

EIA has placed the minimum operating level for U.S. distillate stocks at 92.1 million bbl. Below that level there is danger of supply disruptions.

With increased demand and lower refining capacity, it is doubtful refiners will risk supply problems by testing the minimum level.

RESIDUAL FUEL OIL

Resid demand this winter is expected to advance 2.9% to 1.145 million b/d. This follows a drop of 7.9% last winter to 1.113 million b/d.

Resid demand has dropped in recent years because of intense competition from other fuels, particularly natural gas. Consumption was 1.58 million b/d the winter of 1988-89. It slipped to 1.445 million b/d the following winter, then dropped sharply in 1990-91 to 1.143 million b/d.

Natural gas inroads into resid markets and sluggish economic growth caused the downturn last winter. Resid demand is particularly sensitive to price movements because many utilities and industrial plants can switch to less expensive fuels when resid prices rise.

The sharp drop in resid demand in the winter of 1990-91 was due mainly to the surge in prices related to the Persian Gulf war. Resid prices shot up along with crude prices, while natural gas prices remained relatively low. Much warmer than normal weather also contributed to the decline because resid is used for boiler fuel in heating some large facilities.

Since the drop in 1990-91, winter resid demand has hovered at 1.11-1.21 million b/d. A major reason is that since the end of the gulf war prices have remained relatively stable.

The average refiner sales price of resid to end users fell from 44.4/gal in 1990 to 34 in 1991 and 33.8 in 1992. The latest resid price available this year is for July at 33.

The steady price for resid contrasts with the increase in natural gas prices. This has improved the competitive position of resid and is a major reason for the expected increase in demand. Resid is expected to be able to displace gas consumption in some utilities and industrial facilities.

Resid imports averaging 415,000 b/d are projected for this winter, up 6.7% from last winter when imports dropped as demand slumped. Resid imports were 449,000 b/d in the 1991-92 winter when demand was considerably higher. Imports were as high as 808,600 b/d in the 1988-89 winter.

During the past few winters imports have tended to rise and fall with surges in demand while refinery production has dropped.

The increase in demand this winter will boost domestic refinery production of resid 10.5% to 936,000 b/d. Some of this increase will be due to a rise in exports as lower prices boost world demand and allow U.S. refiners to export more product. Resid exports will increase 50,000 b/d to 205,000 b/d this winter. Exports fell sharply, falling 79,000 b/d to only 155,000 b/d. Sluggish economic activity outside the U.S. contributed to that decline.

Resid stocks are not expected to contribute much if anything to supply this year. It has been projected that only 5,000 b/d will come from stocks.

Entering the heating season total U.S. resid stocks were only 41 million b/d. In recent years that was the stock level at the end of March after winter stocks had been drawn down. During the past six winters resid stocks at the start of the heating season have been in the range of 45-50 million bbl.

EIA has placed the minimum operating stocks for resid at 39.1 million b/d. With stocks already close to the minimum level, refiners won't be able to use them extensively to meet demand surges.

REFINERY CAPACITY, UTILIZATION

The U.S. industry's thin cushion of spare capacity could pose a problem if major accidents of mechanical failures suddenly take significant capacity out of the system. In addition, refiners in recent years have relied less on stock buildup to meet seasonal swings in demand and have relied largely on increased output to meet additional demand.

Refiners, regarding excess stocks as major additional costs, have tried to run their operations to minimize inventories. However, even with that change in operating philosophy, the highest level of refinery utilization is generally in the months leading up to the winter heating season. Although refiners do not rely on huge stocks to supply as much of the market as in past periods, they still increase inventories of distillate and heavy fuel oil in anticipation of higher seasonal demand.

EIA figures show U.S. refining capacity has declined from 15.7 million b/d in August 1991 to 15.14 million b/d in August 1993, the latest data available. Crude runs to stills 2 years ago averaged 13.7 million b/d and this past August averaged 13.8 million b/d.

During this same period, as a result of declining capacity and slow growth in input, the refinery utilization rate has climbed from 88.8% to 92.7% in August 1993. And last June and July the utilization rate topped 95%.

The American Petroleum Institute's monthly refining survey listed U.S. capacity last September at 15.145 million b/a, down from 15.308 million b/d a year earlier. API also showed input to crude units last September up 1.3% at 14.1 million b/d and the utilization rate at 93.1% compared with 90.7% last year. This leaves excess capacity of only 1 million b/d-not much room to meet contingencies.

August and September are key months for building stocks for the winter heating season. Refinery capacity utilization rates tend to be high.

Crude stocks at the end of last September were estimated at 328 million bbl compared with 322 million bbl a year earlier. Distillate stocks were 131 million bbl, up from 128 million bbl last year. And resid stocks were 41 million bbl compared with 47 million at the same time in 1992.

End September distillate stocks represented 39.4 days of supply, based on projected demand. This compared with actual days of supply during 1987-92, which varied from 36.9 to 44.9. This is a substantial change from 1974-83, when end September distillate stocks averaged 61 days of supply.

In recent years, higher levels of days supply generally occurred when demand was lower than anticipated due to warm weather or economic conditions. The lower numbers were years when demand was slightly higher than anticipated or other conditions caused refiners to enter the heating season with stocks below average.

It appears that for operational planning refiners target about 40 days of supply entering the winter season. However, only a relatively small portion of total stocks is available for use. The rest of the recorded stocks is required to keep the system running.

The National Petroleum Council places the minimum operating inventory for distillate at 85 million bbl. Below that level it is anticipated operating problems and shortages would appear. That means that at the start of the heating season distillate stocks usable to meet demand were only 46 million bbl, or about 14 days of supply. That illustrates the importance of continued refinery distillate output to meet winter needs.

Distillate stocks will play a somewhat more important role this year, providing 187,000 b/d of supply, up 10% from last winter. In the winter of 1991-92 stocks provided 233,000 b/d of distillate.

End September resid stocks are only 35.8 days of supply compared with 42.5 days last year. Due to the low level of resid stocks entering the heating season, they will not be drawn down to meet much of the required supply.

The minimum operating level for resid stocks has been estimated at 30 million bbl. Therefore, resid stocks available at end September to meet winter demand were only 11 million bbl. Based on projected winter demand, this represents only 10 days of supply. Imports and refinery output will have to meet swings in demand.

Crude stocks at the end of September represented 73 days of supply of combined distillate and resid.

In recent years refiners have tended to maintain higher crude oil stocks and lower product stocks. That operating philosophy provided flexibility when product demand levels and patterns changed. This is expected to continue this winter.

Crude stocks at the start of winter in 1987-92 ranged from 322 million to 342 million bbl. Stocks this year are on the low side of that range but appear adequate. Worldwide supply is plentiful, and additional imports can satisfy any unexpected surge in demand.

As with fuel oil stocks, there is a minimum operating inventory for crude stocks - 300 million bbl. So the usable stocks are 28 million bbl, amounting to about 6 days of supply for distillate and resid. this is not a huge cushion and again illustrates the need for smooth operation of the transportation, refining, and distribution systems to meet demand.

NATURAL GAS

Winter natural gas demand will continue to inch up, increasing 1.2% to 11.936 tcf this year. Winter consumption increased 3.5% last winter and 4% the previous year. Higher prices will slow the rate of advance this year.

The increased level of economic activity is expected to boost industrial output and demand for natural gas. Industrial demand will be up 2.11% at 4.071 tcf compared with only 0.5% last winter.

Residential demand will be up 1% at 3.736 tcf. New housing construction and conversions from fuel oil will boost demand. Colder weather will make only a minor contribution. Residential demand surged 8.7% last winter as weather returned to normal following a very warm winter.

Demand in the commercial sector is expected to be up 1.1% at 2.01 tcf. This follows a 7.5% increase last year. Increased economic activity is the major reason for the gain this year, while colder weather boosted demand last year.

Electric utility demand for gas will slip for the second year in a row, dipping 0.7% this winter to 1.09 tcf. The slump will be due to higher prices and increased hydroelectric output. Demand last winter fell 6.8% because of a surge in nuclear and hydroelectric output.

Natural gas consumption for plant and pipeline fuel is projected to inch up 1.2% this winter to 1.029 tcf, following a 2.3% increase last winter.

PRICES

The average price of world export crude oil has been sliding in recent weeks as refiners have secured adequate feedstocks to meet winter fuel demand.

The price of world export crude oil started the year at an average $16-86/bbl. There were minor fluctuations during the next 9 months. However, there has been recent price weakness, and the average for the week of Oct. 29 was $14.97/bbl, down 11.2% from the start of the year. Lower crude oil prices allow refiners to carry larger crude stocks without increasing costs.

Fuel oil prices also have shown some weakness in recent weeks and are well below those of a year ago.

EIA data for the week of Oct. 29 shows the spot price of No. 2 heating oil, the New York reseller barge price, at $23.26/bbl. This is down from $25.26/bbl at the start of the year and well below the $27.29/bbl a year earlier.

The residual fuel oil spot price was $14/bbl, down from $15/bbl the week of Jan. 1 this year and $17.90/bbl a year earlier.

The lower prices for fuel oil this heating season will improve the competitive position for heating oil. The maj . or competing fuel for heating oil is natural gas. While fuel oil prices are significantly lower than last year, natural gas prices are substantially higher. So major consumers such as electric utilities and large industrial users will turn to fuel oil to meet a larger share of their winter fuel needs, particularly during periods of peak demand.

Natural gas demand patterns are shifting away from their historical peaks and valleys. As a result, the normal seasonal fluctuation in prices has not occurred this year. The week of Oct. 29 the price of gas on the New York Mercantile Exchange (Nymex) was up only 1.7% from a year earlier at $2.35/MMBTU. However, for the first 10 months of this year natural gas prices on Nymex have averaged $2.08/MMBTU, up 26.8% from the $1.64/MMBTU for the same period of 1992.

Copyright 1993 Oil & Gas Journal. All Rights Reserved.