Sunday, February 15, 2009

The EIA notices Retail Price Inelasticity in Heating Oil

From the most recent "This week in Petroleum":

Two factors may offer an explanation for the smaller decline in retail heating prices. The first is the relative strength of the global distillate market. Distillate fuel includes both heating oil and diesel. In the United States, heating oil makes up a relatively small portion of the domestic distillate market while diesel fuel makes up most of the remainder. This is true for much of the rest of the world. Until fairly recently, distillate prices have shown surprising strength compared to other petroleum products due to strong global demand for distillate. As a result, distillate prices did not fall as much as crude oil prices.

The second factor may be related to events of the past summer. The summer is when heating oil customers are typically offered contracts to lock-in prices for the upcoming winter. The price for residential heating oil reached its historic peak last July, averaging $4.53 per gallon. Some heating oil customers may have been anxious about those unusually high prices and wanted to shield themselves from possibly higher prices in the winter. When a customer locks in a contract with a heating oil company, the company often enters into a similar contract with a wholesaler, guaranteeing they will be able to supply that customer with enough heating oil for the winter at a stable price. (This type of commitment is even required by law in Connecticut.) Moreover, many heating oil companies buy some of their heating oil in the off-season to ensure an adequate supply for the winter, regardless of any pre-arrangement with their customers. So another reason heating oil prices this winter have not fallen as quickly as crude may be that some of the volume heating oil dealers (and customers) bought earlier was quite expensive. Thus, a portion of this additional expense may have been passed on to the customer during this heating season.

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