ANALYSIS: Despite seasonal shift, heating oil remains strong

ANALYSIS: Despite seasonal shift, heating oil remains strong

New York (Platts)--15May2006

With intense scrutiny being given to every tick in the gasoline market,
little mention has been made of the rather meteoric rise in heating oil
futures despite its lack of seasonality.

Front month heating oil on the New York Mercantile Exchange settled at
$2.047/gal last Friday, a week-over-week gain of 9.06 cents/gal, and an
advance of 18.44% year-to-date, the highest level ever for this time of year,
and making natural gas look like a downright bargain.

Falling sway to more stringent specifications, the introduction of ultra
low sulfur diesel in June has created supply and distribution uncertainties,
not unlike the gasoline market. However, distillate demand represents far less
of total US petroleum demand and the introduction of ULSD has not resulted in
a fractured futures market the way specification changes in gasoline have,
making the issue much less visible. Total distillate demand represents about
20% of total petroleum demand while gasoline accounts for about 45%.

The gasoline market has been snarled by the switch over to ethanol-based
gasoline from MTBE and the subsequent fracturing of the futures market (there
are two contracts that can be used to hedge, causing a liquidity crunch),
which left supply/demand balances a bit tight ahead of driving season, sending
prices soaring and driving the entire complex to near-record price levels.

While gasoline balances are tight, the opposite is true for distillates.
Total distillate inventories at 114.7 million barrels for the week ending May
5 were 10.7 million barrels above year-ago levels and 7.3 million barrels
above the five-year average, according to the most recent data from the Energy
Information Administration. Within distillates, heating oil stocks at 42.9
million barrels were 5 million barrels above year-ago levels and 3.1 million
barrels above the five-year average. Low sulfur diesel inventories at 71.8
million barrels were 5.7 million barrels above year-ago levels and 4.2 million
barrels above the five-year average.

Low sulfur diesel can be made into ultra low sulfur diesel by
hydrotreating the product, unlike reformulated gasoline which can not be made
into reformulated blendstock for oxygenated blending, which then begs the
question as to why heating oil prices remain so stubbornly high.

Historically high gasoline prices have not only pulled heating oil, and
crude, prices higher, but have sent the gasoline crack spread soaring, which
potentially could cause distillate inventories to fall as refiners maximize
gasoline production.

Heating oil prices are certainly not being pulled higher by natural gas
-- if anything, the opposite should be occurring. Working gas in storage
neared record-high storage of 1.989 Tcf the week ending May 5, according to
EIA, sending the front month contract to $6.28/MMBtu, its lowest settlement in
nearly a year.

By comparison, the front month heating oil contract settled at
$14.76/MMBtu, $8.48/MMBtu over natural gas and a spread sufficient to cause
fuel switching except that this is a shoulder season. Should the pricing
discrepancy between the two markets persist heading into the fall, heating oil
could put a floor in the natural gas market, particularly should distillate
inventories fall, rather than build, if refiners favor gasoline production.

--Linda Rafield, linda_rafield@platts.com

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