Interview: API honcho on tight heating oil market -------------------------------------------------------------------------------- oil

By Myra P. Saefong, CBS.MarketWatch.com Last Update: 5:15 AM ET Nov 25, 2000 NewsWatch Latest headlines

WASHINGTON, D.C. (CBS.MW) - Heating-oil futures prices recently touched their highest level ever, boosted by market concern over the tight supplies situation in the U.S., ahead of the winter season.

Those tight supplies probably mean that consumers will end up paying much more for heat this winter than they did last year in the Northeast, where 35 percent to 40 percent of the homes use heating oil.

John Felmy, director of policy analysis and statistics at the American Petroleum Institute - a trade association representing the petroleum industry -- shared his thoughts with CBS.MarketWatch.com on the recent jump in heating oil prices and what it may mean for consumer heating bills.

CBS.MW: Could you talk about the recent jump in heating oil prices to historic levels and about what caused this jump?

Felmy: It was a combination of factors.

It all traces back to supply and demand. Crude prices remain very high. They've been running at about $35 a barrel for a few days and they've been well in excess of $30 for many months now so first is the crude costs.

But then, we've had very strong demand for both types of distillate fuel: low sulfur for diesel and high sulfur for heating oil.

Given that our refinery system is running at pretty much maximum rate right now and well in excess of 90 percent, we're straining to supply customers. The balance of strong demand and limited supply of course provides upward price pressure in a market situation.

CBS.MW: Could you put the level of distillate supplies into perspective relative to last year and the average for this time of year?

Felmy: We've had substantial increases in total inventories from the bottom in about mid-April, the low level of inventories was about 95 million barrels of inventory and now we're in excess of 115 million, so we've had a 20 million-barrel increase in inventories.

We've been working hard as an industry to build up inventories, but it's been limited by strong demand.

We just released our monthly report that showed the third month in a row of record distillate production. We've also had strong imports up well above average and above year-ago period, so we're producing a lot of supply, but at same time inventories are not building commensurate with that strong production.

The product appears to be moving out of our primary inventories, which API and the Department of Energy measure into either, we believe, into the secondary inventories which are not measured by either organization.

CBS.MW: Do current supplies indicate that we may have a supply shortage this winter?

Felmy: No.

We've been producing record levels of high sulfur and low sulfur distillate this year. You can never guarantee anything because we still have to see how cold the winter is, but based on our experience of how much we're producing this year, we seem to be well-above average and above last year because we continue to set monthly (supply) records for the product.

CBS.MW: But why is the market concerned that we may have a shortage then?

Felmy: Basically people are remembering what happened last year.

We saw the tight gasoline situation this year where we experienced price increases as a result of supply and demand conditions. Given that refineries are running at very high levels, but yet our distillate inventories are below last year's levels, it has people concerned.

There tends to be somewhat of an overestimate on what the role that primary inventories play in supply and consumption.

For the heating season, about 90 percent of consumer demand for distillate is supplied by product that's produced during the heating season and only about 10 percent is the inventories going into a heating season.

CBS.MW: Is the drop in supplies, compared to year-ago levels something to really be concerned about?

Felmy: Depends on what happens with weather. All of our energy markets are under great strain - petroleum, natural gas and the electric system are under great strain because of strong demand and limited ability to build new infrastructure.

If you have any kind of problem in anyone one of those sectors, they're all inter-related and could lead to ripple effects throughout the energy infrastructure. I watch the data carefully and try to report it to public so they're aware of supply/demand conditions.

CBS.MW: What would it take to build up these supplies?

Felmy: We have to either expand the existing refinery system and that's very limited in terms of regulatory structure that we face or we need to build new refineries. That's even more difficult because we haven't built a full-scale refinery in 25 years. But demand has increased dramatically and so we've only been able to meet that demand by expanding existing refineries and additional imports. On the demand side, the alternative is to improve efficiency. The situation continues to be very tight.

CBS.MW: How much has demand increased?

Felmy: Total deliveries are the closest measure of demand we have right now.

They have increased, for total distillate fuel, have increased year-to-date (January to October) by 3.4 percent according to latest monthly statistical report.

Low sulfur distillate, which is mostly diesel fuel, has increased by 4.7 percent and high sulfur (heating oil) has increased by 0.6 percent over the same period last year. That's reflective of a strong economy and the very strong increase in diesel consumption along with increases in demand from heating oil.

For the month of October, high sulfur distillate actually increased by 7.1 percent. So you had a slowdown of deliveries for part of the year and now you're seeing very strong demand at this point, as we get ready for the winter.

CBS.MW: What about the heating oil reserve in the Northeast that was set up in mid-September? Could that help alleviate the supply situation?

Felmy: It could play a role if we have a supply disruption. We've been concerned about it in terms of setting up and then its use. There are some unanswered questions about the trigger mechanism that would be used to release it.

It terms of setting it up: 2 million barrels of heating oil was transferred from commercial inventory to this government inventory so that amount of product went off the market.

Second: the concern is how will this influence the commercial inventory holders. If you're concerned about a release of the government reserve that could say, drive down prices, it could cause severe financial problems for those holders of commercial inventories.

We're just waiting to see what the exact determination is of what the trigger mechanism will be for releasing the product on the market. If the trigger mechanism is set too low, it could have an impact on imports (and) could influence those suppliers if they think that some type of a release could drive down prices and yield lower prices than what's profitable to bring in those imports. And imports play a very important role in terms of alleviating supply/demand situations like we saw last year.

It's a relatively small amount compared to total demand but it's the expectations that the size of the reserve could lead on the part of suppliers that has us concerned.

CBS.MW: How will the current supply situation affect consumer prices? Will it be visible in the amount consumers pay for heat when the winter cold hits?

Felmy: Depends on what the weather is. We're seeing heating oil prices up by as much as 50 percent over last year's initial levels at this time. So it comes down to how much heating oil will the individual consumer use. If we have warmer than last year, then they'll consume less so that in terms of their total cost of heating, counteracting (the higher cost). But if we had very cold weather, it could add to cost of consumers.

Average retail heating-oil prices for (the week ending Nov. 10) were at $1.506 (per million British thermal units). A year ago at that time, it was $1.054 so that's around 44 percent higher.

CBS.MW: So is it reasonable to say that heating bills would be actually 44 percent higher if consumers use the same amount as last year?

Felmy: Absolutely. If they use the same amount, then it'll be that much higher with the price change.

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-- Carl Jenkins (somewherepress@aol.com), November 28, 2000