Fuel Costs Heating Up as Cold Weather Comes

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18 Sep 2000, 11:58am EDT

09/18 00:01 Fuel Costs Heating Up as Cold Weather Comes: Economic Outlook By Art Pine

Washington, Sept. 18 (Bloomberg) -- While gasoline prices have eased a bit from June's record levels, for those in the nation's colder climates there's a new worry -- the prospect of soaring home-heating costs in the next few months.

At first blush, the outlook seems grim. Energy Department forecasts show that average home heating-oil prices could soar to $1.33 a gallon by February, up from $1.18 last year and 80 cents in 1998. Natural gas prices could rise $8.40 for 1,000 cubic feet -- well above last year's $6.61 and the previous year's $6.27.

In both cases the spike stems not just from higher crude prices, but also from low inventories and limited production capacity -- a consequence of unusually low crude prices in 1998, which led the industry to cut stockpiles and slow exploration.

The options are limited. Unlike most motorists, homeowners can't easily cut consumption. And last week's agreement by the Organization of Petroleum Exporting Countries to boost production of crude oil was too small to help much. Even if it were larger, relief could be months away. There's a shortage of tankers needed to get the oil here.

``The country just isn't prepared for a cold winter'' this year, said Steve Brown, energy economist at the Federal Reserve Bank of Dallas.

The prospect of soaring heating fuel prices threatens to become a political issue, particularly in the northeast and upper Midwest. The House Government Reform Committee has scheduled hearings on the issue for Thursday, and many analysts expect the presidential candidates to make it an issue soon.

Refiners' Choice

With auto fuel prices rising, refiners haven't wanted to rebuild gasoline inventories quickly for fear they'd have to sell their stockpiles at lower prices later. So they continued to produce gasoline more slowly and steadily, rather than switch early on to producing heating oil.

The oil producers' cartel exacerbated the problem in March 1999 when it began cutting production of crude oil to push prices up. But demand for gasoline also is up sharply -- a combination of the booming economy and gas-guzzling sports-utility vehicles.

The Clinton administration has taken a cautious approach. In late 1997, when the collapse of the Asian economies sent world oil prices plummeting, squeezing the oil-producing countries, Washington did nothing to slow the slide. Policy-makers said they were counting on low oil prices to help hold inflation down here.

In early 1999, when oil prices fell to $10 a barrel, desperate producing countries finally cut output, and world oil prices soared. Again, the administration took a hands-off posture: Energy Secretary Bill Richardson said the U.S. position was that ``market forces should dictate prices.''

Prodding Oil Producers

Since then, Richardson has traveled to the major oil states to prod officials into increasing their oil production, but the high-profile effort has yielded only meager results. While the producers' cartel has raised its official output targets modestly, the action has had no major effect on actual production levels.

Philip Verleger, an energy economist with the Brattle Group, a Cambridge, Mass., consulting firm, argues that the administration's caution has contributed to the problem.

Washington could have helped brake the oil-price plunge in 1997 by buying more oil for the U.S. Strategic Petroleum Reserve, but administration officials rejected that move, he said. ``They were so happy that low oil prices would help hold inflation down, they didn't consider the medium-term consequences.''

By the time the cartel members decided to cut production, Verleger contends, the administration was left with little to do but stand by quietly. Not having helped the cartel when prices were low, he says, it had scant influence later when it wanted producers to boost output.

Verleger says the administration also missed a bet in rejecting suggestions that it counter the oil price hike last autumn by selling oil from the SPR and later buying it back in April. Had Washington ``swapped'' as little as 2 million barrels a day, he says, oil prices would be $5 to $6 a barrel lower.

Baily's Response

Administration officials reject the criticism that they failed to develop any real strategy to manage the energy problem, and Martin Baily, chairman of the President's Council of Economic Advisers, says Clinton is considering new steps to help stabilize heating-oil prices by increasing incentives for refiners.

Clinton said last week the government was trying to fill a smaller heating-oil reserve he set up in July, but that only holds 2 million barrels. By Friday, he was pondering everything from renewing his exhortations to oil-producing countries to tapping the SPR. ``All options remain on the table,'' his spokesman said.

Still to be seen is what effect the higher prices will have on the economy. Analysts warn that if oil prices remain at around $36 a barrel for very long, consumers might begin to pull back and the economy could slow more sharply than expected. There are similar worries about Europe and Japan.

``A bigger energy shock would disrupt our forecast'' for moderate growth next year, said Richard Berner, economist at Morgan Stanley Dean Witter. He predicts that if the price surge doesn't moderate, the economy could slow to a 2.5 percent growth rate early next year instead of 3 percent to 3.5 percent.

Inflation Risk

It also could exacerbate inflation. Airlines already have raised their fares as a result of the rise in jet fuel prices, and last week Union Pacific Corp.'s railroad unit, the largest U.S. rail carrier, said it will raise rates an average of 3 percent in early October because of higher costs for diesel fuel.

To be sure, there still is some hope that heating-oil prices may not get out of hand. The industry is now ``really pushing'' to shift more of its production to heating oil in an effort to mitigate the expected price surge, said Dave Costello, an Energy Department forecaster.

And the rise in heating oil prices may peak early -- perhaps as soon as mid-October, Verleger said. Panic-buying by homeowners who want to lock in today's prices could reduce demand significantly by the time the cold sets in, he said.

Natural gas prices are less likely to drop, analysts say. It's harder to build more inventories of natural gas because it's more difficult to store than oil is, and the natural gas industry is regulated by states, each of which has different rules that refiners must meet.

If anything, many analysts say the best hope may lie with the weather. If the winter proves mild -- and demand for home heating fuel proves relatively low -- prices may not soar to worst-case levels. So far, expectations are for colder weather than usual. But forecasts of any kind can be wrong.

http://quote.bloomberg.com/fgcgi.cgi?ptitle=Bloomberg%20Energy&touch=1&T=energy_news_front.ht&s=AOcWTfBWuRnVlbCBD

-- Martin Thompson (mthom1927@aol.com), September 18, 2000


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