# Presentation: 746700

## Winter Distillate Outlook

*Joanne Shore *
*Energy Information Administration*
- PPMCSA Annual Meeting & Trade Show
- September 2000

**Notes:**
Throughout the summer, gasoline prices have drawn most of the public’s attention, but EIA has been concerned over winter heating fuels as well.

Distillate inventories are likely to begin the winter heating season at low levels, which increases the chances of price volatility such as that seen last winter.

## Distillate Prices Increasing With Crude Oil

**Notes:**
This slide shows the strong influence crude oil prices have on retail distillate prices.  

Distillate tracks the crude price increases seen in 1996 and the subsequent fall in 1997 and 1998.  Distillate prices have also followed crude oil prices up since the beginning of 1999.  

Residential heating oil prices on the East Coast (PADD 1) are estimated at about $1.20 this August – almost 40 cents per gallon higher than last August, which is an increase of almost 50% over year ago prices.  
About 24 cents or 60 percent of the increase is due to the increase in crude oil costs;
Another 6% of the increase represents the return to more normal spreads; 
And the remaining 33% increase is due to the very tight distillate market balance.  

Diesel fuel prices behaved similarly, though with less of a spike last winter.  The average East Coast diesel price in August was $1.48 per gallon, 33 cents or 29 percent higher than a year ago.

## Factors Driving Prices & Forecast

**Crude Oil Prices**
**Distillate Price Spread Affected by Supply/Demand Balance**
- Demand
- Production
- Net Imports
- Inventories -- Measure of Balance
**Distillate Forecast **

**Notes:**
The rest of the talk will discuss how we got where we are today and what we expect this winter.

I will focus on two drivers behind prices: the crude oil prices and the spread between spot/wholesale distillate prices and crude oil.  This spread is a function of the balance between demand and fresh supply (production and net imports).

Finally I will discuss the current forecast for distillate prices this winter.

## First Factor Impacting Distillate Prices: Crude Oil Prices 

**Forecast: Energy Information Administration  September Short Term Energy Outlook**

**Notes:**
World oil prices have tripled from their low point in December 1998 to August this year, pulling product prices up as well.  But crude prices are expected to show a gradual decline as increased oil production from OPEC and others enters the world oil market.  We won’t likely see much decline this year, however, as prices are expected to end the year at about $30 per barrel.
The average price of WTI was almost $30 per barrel in March, but dropped to $26 in April as the market responded to the additional OPEC production.
However, prices strengthened again, averaging almost $32 in June, $30 in July, and $31 in August.
The continued increases in crude oil prices indicate buyers are having trouble finding crude oil, bidding higher prices to obtain the barrels available.
These crude oil  price projections reflect: 
Fairly low world demand growth during 2000 of 1.3 percent, or 1.0 million barrels per day.
Non OPEC production growth during 2000 of almost 1.1 million barrels per day.
Growth in Iraqi production of 700 thousand barrels per day from Q1 to Q4 2000.  Iraqi production is estimated at more than 3.0 million barrels per day in the fourth quarter 2000.
Growing OPEC leakage over the current OPEC target.
Slow projected inventory build of 0.6 million barrels per day in 2000 and 0.4 million barrels per day in 2001.

## High Crude Prices Go With Low Inventories

**Forecast: Energy Information Administration  September Short Term Energy Outlook**

**Notes:**
As global production changed relative to demand, the world moved from a period of “over supply” in 1998 to one of “under supply” in 1999 and 2000.  Inventories are a good means of seeing the imbalance between petroleum production and demand.  For example, when production exceeds demand, inventories rise.  A large oversupply will put downward pressure on prices, while undersupply will cause prices to rise.

OECD inventories illustrate the changes in the world balance.  OECD inventories rose to very high levels during 1997 and 1998 when production exceeded demand and prices plummeted to almost $10 in December 1998.  However, when inventories fell to the low levels seen above during 1999 and early 2000 as demand exceeded production, prices rose to $35 per barrel at one point, and have settled above $30 per barrel.

All scenarios shown leave inventories low through the winter.  It would take an increase of 1 million barrels per day of production staring in the fourth quarter to get stocks back to normal levels by March before the start of the high summer gasoline demand period.
The base case has stocks very slowly recovering, but not reaching normal by June of 2001.
The 0.5 million barrel increase over the base doesn’t reach recovery until June, increasing the potential for volatility through the next gasoline season.

## Second Price Component: Spread Impacted by Distillate Supply/Demand Balance

**Notes:**
While crude oil prices will be a major factor impacting distillate prices this winter, another important factor is the U.S. distillate supply/demand balance, as measured by distillate stocks.  

The distillate supply/demand balance influences the spread between spot distillate and spot crude oil prices.  For example, when stocks are higher than normal, the spread will be lower than usual.  This spread is the price incentive that encourages or discourages changes in supply.  

While high stocks in the distillate market are good news for consumers, an excess is bad news for refiners.  

Distillate spreads during the winter of 1998-99 and throughout most of 1999 were well below average.  Distillate stocks were very high during this period, partially as a result of warm weather keeping demand down.

Last winter (1999-00) began with high stocks and low distillate spreads (4 cents below average in September).  Then in December, stocks began a decline that continued into January.  In January, spreads increased dramatically.    

In June of this year, distillate spreads had dropped to 2.5 cents per gallon as a result of crude oil prices increasing faster than product prices.  But by July spreads had strengthened to over 7 cents per gallon and in August they have averaged 15 cents, which is almost 9 cents above average --indicating stocks are low.  

## Distillate Stocks are Low – Especially on the East Coast

**Source: EIA**

**Notes:**
Distillate stocks are normally built during the summer for use during the winter as shown by the normal band.

Currently, stocks are very low for this time of year. This graph shows East Coast inventories, which at the end of August, were well below the normal band (over 9 million barrels or 19% below the low end of the band). The East Coast is about 31% lower than its 10-year average level for this time of year. 
We focus on the East Coast (PADD 1 ) because this a region in which heating oil is a major winter fuel.  Furthermore, the East Coast consumes almost 2/3 of the nation’s heating oil (high sulfur distillate).  

December 1999 was the turning point.  Stocks were well within the normal range through November 1999, but in December, they dropped below the normal band and have not returned to normal levels since.   

As was evidenced this summer in the gasoline market, and last January and February in the Northeast heating oil market, below average stock levels translate to increased potential for price volatility.

## Distillate Stocks Are Important Part of East Coast Winter Supply

**Source: EIA**

**Notes:**
Why do stocks matter in the Northeast?  They are the nearest source of supply when anything unexpected occurs, and they supply a significant portion of demand during the peak heating season.

Stocks are normally an important part of PADD 1 winter distillate supply.  Over the last 10 years, they provided about 15% of supply during the peak winter months of January and February.  One of the biggest stock draws we have seen was in January 1994, when a prolonged severe cold spell required 666 MB/D of stocks, covering almost 36% of demand for that month.

Stocks supply the East Coast with about 260 MB/D on average in January and 280 MB/D in February.  Those supplies represent draws of about 8 million barrels in one month.  

PADD 1 refineries meet about 25% of demand during January and February, and other PADDs -- mostly PADD 3 -- supply 40-50% of the region’s needs.

Imports generally supply about as much as stocks during the peak months, with most of the product coming from Canada, the Virgin Islands and Venezuela.  During the peak months, product from more distant sources also helps to supply the region.

Thus, about 60% of the East Coast’s supply comes from distant sources, so if cold weather increases demand, resupply from these distant sources can take several weeks.

## Winter Demand Impacted by Weather

**Source: National Oceanographic and Atmospheric Administration; Normals: EIA.**

**Notes:**
Heating oil demand is strongly influenced by weather.  The “normal” numbers are the expected values for winter 2000-2001 used in EIA’s Short-Term Energy Outlook.

The chart indicates the extent to which the last winter exhibited below-normal heating degree-days (and thus below-normal heating demand).  Temperatures were consistently warmer than normal throughout the 1999-2000 heating season.  This was particularly true in November 1999, February 2001 and March 2001.  For the heating season as a whole (October through March), the 1999-2000 winter yielded total HDDs 10.7% below normal.  Normal temperatures this coming winter would, then, be expected to bring about 11% higher heating demand than we saw last year.

Relative to normal, the 1999-2000 heating season was the warmest in at least 25 years (the next-warmest over that time period was 1995-1996 at  8.5% below normal).  The probability that this winter will be at least somewhat colder than last winter is about 95%.  The probability that this winter will (overall) be 10% (or more) colder than last year is above 56%, while the probability that this winter will be 20% (or more) colder than last winter is about 10%.

While normal temperatures this winter would imply broad increases in heating demand across the North Central and Northeastern United States, the potential for high demand growth appears to be greatest in the Midwest.  Thus, natural gas and propane consumption under normal weather conditions this winter would be expected to exhibit higher year-over-year growth rates than heating oil. 

## Warm Winters Held Heating Oil Demand Down While Diesel Grew

**Source: EIA**

**Notes:**
To understand the inventory situation, we must look the balance between demand and supply that drives inventories up or down.  First consider demand.  

Most of the remaining charts deal with total distillate demand.  Total distillate demand includes both diesel and heating oil.  These are similar products physically, and prior to the low sulfur requirements for on-road diesel fuel, were used interchangeably.  But even today, low sulfur diesel can be used in the heating oil market, but low sulfur requirements keep heating oil from being used in the on-road transportation sector.

The seasonal increases and decreases in stocks stem from the seasonal demand in heating oil shown as the bottom red line.  Heating oil demand increases by more than 50 percent from its low point to its high point.  But it can increase much more as can be seen in January 1994, when high sulfur heating oil demand doubled over its more typical levels.

Heating oil demand has not been growing, and the warm winters over the last few years have diminished the peak levels.  
Look back at January 1994 and you see the peaks for the last several winters are 500 thousand barrels per day lower than what we experienced during that very cold month.

Diesel demand is where the annual growth in distillate has been.  

## Distillate Demand Strong in December 1999

**History:  EIA;  Projections: Short-Term Energy Outlook, September 2000**

**Notes:**
U.S. distillate demand during the last winter (1999-00) was almost 5% higher than in the prior year, due mainly to diesel demand growth, since warm weather kept heating oil demand from growing much.

Last December, when stocks dropped below the normal band, demand was almost 12% stronger than the prior year, although U.S. temperatures were only 6% colder.  

December demand seemed stronger than the weather would have indicated.  Some of this strength may have come from Y2K activities.  For example, anecdotal evidence indicates some utilities removed themselves from the natural gas system and used distillate during the year turnover to assure uninterrupted electricity supply.  

Demand is expected to increase 3.2% this winter over last.  The forecast assumes normal winter weather, which would be 11% colder than we experienced last winter.  Demand growth is expected to be slightly lower than in the prior year in spite of the colder weather as a result of the economy slowing and higher prices dampening diesel demand. 

This forecast is highly uncertain.  It depends on weather, the economy, and even the natural gas market.  Today’s very high natural gas prices can increase distillate demand by large consumers as they switch from natural gas to heating oil.

## Dec 1999 & Jan 2000 Production Fell, But Rebounded with Price

**History:  EIA;  Projections: Short-Term Energy Outlook, September 2000**

**Notes:**
Will production be high enough this fall to bring stocks back into the normal range?

Last winter, production was cut back in December, which, when combined with the strong increase in demand, resulted in the large strong stock draw.  But this did not diminish the typical production decline that occurred in January, leaving stocks precariously low.
As December began, margins were low, and November weather had been 16% warmer than the prior year.  
Stocks were in the normal range, and companies were still smarting from the extremely low margins of the prior winter.  
Refiners reduced production to the prior year’s levels as a result.

When the cold spell hit the Northeast at the end of January and caused prices to spike, production rebounded in response.  However, increased imports were the main source of supply increases following the price spike.

Production is projected to increase about 220 MB/D or 6.5% this winter. Distillate production can be increased by increasing crude oil inputs to refineries -- which increases all product production -- or by increasing distillate yields, which results in a switch in volumes between products.  A higher distillate yield means higher distillate production but lower gasoline and/or jet fuel production.

The forecast distillate production this winter is increasing over last winter mostly due to increased crude oil throughputs of about 525 MB/D, although yields are also assumed to increase.

## Higher Yields Can Be Achieved

**History:  EIA;  Projections: Short-Term Energy Outlook, September 2000**

**Notes:**
While the current forecast is showing higher distillate production than last year, there is room for yet more volume through refiners switching to higher yields than those being forecast.  This will only happen if economic incentives evolve to encourage this change. Current high spreads indicate those incentives may occur.

This graph shows the distillate yield pattern over the last few years.  Generally yields rise in the fall to build stocks for winter distillate use.  On average, the yield increase during the fourth quarter is about 2% higher than the yield average of the lowest yield months of June, July and August. (Recognize that a 1% change in yield is about a 150 MB/D change in distillate production, which is about 4% of winter demand.)

During the fall of 1996, the winter season began with very low stocks, but refiners pushed yields to very high levels and regained some of the lost ground.

During the winter of 1998-99, we saw a production decline of about 160 MB/D, as refiners began the season with very high stocks and they did not want to build them further.  The production reduction was due mainly to yield reduction.  

As shown on this chart, 4th quarter yields are projected to increase about 0.6% over yields seen last year.  But they can go higher as seen in 1996.  If yields in 4th quarter 2000 were similar to 1996, we would have about 100 MB/D more production.  

## Unusual Net Imports May Only Be Available at a High Price

**History:  EIA;  Projections: Short-Term Energy Outlook, September 2000**

**Notes:**
Imports are a small, but sometimes crucial contributor to supply.  

Last winter, imports were the main source of supply increase following the price spike.

Imports are expected to be relatively normal this winter.  Added imports would probably only be available at a high price, because Europe is low on distillate stocks and will be competing for the available barrels.  

## Distillate Stocks Expected to Remain Low

**History:  EIA;  Projections: Short-Term Energy Outlook, September 2000**

**Notes:**
When EIA’s demand forecast is combined with its outlook for production and net imports, distillate stocks are projected to remain low for the rest of the year.
- Stocks are beginning at very low levels.  The end-of-August distillate stock level is nearly 21% less than last year (29 million barrels), and about 15% below the 10 year average for end of August levels.  
- But the East Coast is 39% behind year-ago levels, and about 31% below end of August 10-year average levels.

Over the last 10 years, the average stock build from the end of August through end of November has been about 10 million barrels.  We are forecasting about a 12-15 million barrel build, which does not get us into the normal band.  Forecast stocks peak at the end of November at 127 million barrels, about 13 million barrels below the bottom of the normal band.

If, however, economic incentives are high enough, we might see more inventory than shown.  Higher yields and crude utilization rates from domestic refiners alone could provide another 5-10 million barrels by the end of November over those shown -- assuming demand is not growing stronger than forecast.

## Distillate and Crude Oil Price Forecasts

**Distillate and Crude Oil Price ****Forecasts**

**Source: Spot Prices, S&P DRI Platt's; Retail, EIA**

**Notes:**
Our forecast for diesel fuel and residential heating oil prices on the East Coast is being driven by higher crude oil prices than last year and higher spreads.  

Crude oil is projected to average almost $2.50 higher this winter than last – which translates to about 6 cents per gallon for petroleum products.

Heating oil on the East Coast is shown averaging about $1.32, and diesel about $1.51 per gallon. These prices are about 12-15 cents per gallon higher than prices last winter as a result of both higher crude oil prices and very tight markets resulting from the low stocks.  

## Consumer Winter Heating Oil Costs

| Average Northeast Household Heating with Oil |  |  |  |  |
| --- | --- | --- | --- | --- |
|  | 97-98
Actual | 98-99
Actual | 99-00
Actual | 00-01
Forecast |
| Gallons | 636 | 647 | 643 | 683 |
| $/Gal | $0.93 | $0.80 | $1.19 | $1.32 |
| Cost ($) | $591 | $518 | $765 | $901 |

**Forecast: Energy Information Administration  September Short Term Energy Outlook**

**Notes:**
Using the Northeast as an appropriate regional focus for heating oil, the typical oil-heated household consumes about 680 gallons of oil during the winter, assuming that weather is “normal.”

From the table it is clear that the previous three winters generated below  normal consumption rates.  Last winter, consumers saw  large increases over the very low oil prices seen during the winter of 1998-1999 but, outside of  the cold period in late January/early February they saw relatively low consumption rates due to generally warm weather.

Even without particularly sharp cold weather events this winter, we now think consumers are likely to see higher average heating oil prices than were seen last winter.

If weather is normal, our projections imply New England heating oil customers would be expected to pay about $140 more this winter for heat than last year. 

## Conclusion

**Distillate stocks likely to be low going into winter – increases odds for volatility**
**Prices expected to average 12-15 cents per gallon higher than last winter even without volatility**
**Consumers will need to purchase more fuel this winter if weather is normal**
**Higher prices times higher volumes equals higher bills this winter than last**

**Notes:**
In conclusion – The U.S. may be starting winter with low stocks in all the heating fuel sectors. 

Low stocks translate to an increased potential for price volatility.

Consumers may be paying more this coming winter than they did last year -- mainly because colder weather will increase the volumes they will burn.