The pressure is on in the US heating oil market as physical and futures prices climb amid a tightness in supply that is being punctuated by the possible loss of some 690,000 b/d of US Atlantic Coast refining capacity.
"If this winter is even modestly cold the demand for heating oil shall rise obviously, but the supplies of heating oil will be short and that shortage might well become quite severe," said analyst Dennis Gartman of the Gartman Letter. "Heating oil's term structure through the winter is already backwardated, but it may become egregiously so, and indeed it should become so."
The November/December spread for NYMEX heating oil was around 77 points/gal on October 6, after having slipped from a contango structure for most of the year. At the same time in 2010, the front-month spread was around minus 1.89 cents/gal.
The change in the structure comes as heating oil stocks along the USAC were down 24.73% for the week ending September 30 at 31.488 million barrels from the same period in 2010, US Energy Information Administration data showed.
At the same time, USAC stocks were 19.45% below the five-year average of 39.093 million barrels, the EIA data showed.
Still, some analysts contend that there is room to expand the US' refining capacity, which could make up for a loss of capacity on the USAC.
"Crude runs are at 15.1 million b/d versus a refining capacity of 17.6 million b/d, so that leaves 2-1/2 million b/d of spare refining capacity in the US, so you can close down 700,000 barrels and there would still be enough spare capacity around," said Michael Wittner, head of commodity research Americas at Societe Generale.
As heating oil stocks over the past eight weeks have declined in an unusual counter-seasonal trend, Wittner said it remains too early to tell if supplies will be even tighter heading into the winter.
"The downtrend in stocks is not clear because demand on a year-on-year basis has not been that strong," he said.
Energy analyst Tim Evans of Citi Futures Perspective concurred, noting that a divergence remains between NYMEX heating oil futures and inventory levels.
Front-month heating oil futures on NYMEX are running about 27% higher in October 2011 than the average a year earlier of around $2.2184/gal.
Total US distillate stocks for the week ending September 30, were 9% below year-ago levels, but still 4.1% above the five-year average.
But Evans said if the figures from large stock increases in 2009 and 2010 were not included, current stock levels are more than 18% above the five-year average for the period between 2004 and 2008.
"We also have the spare refining capacity; there is no refining bottleneck," Evans said.
PHYSICAL MARKET HIT BY CLOSURES
Yet, in the physical USAC heating oil market, the loss of production from ConocoPhillips' idled 185,00 b/d Trainer, Pennsylvania, refinery, has resulted in tighter supply, higher price differentials and provided a glimpse into the region's transformation as the loss of additional refining capacity continues to loom.
ConocoPhillips shut its refinery September 30 as part of its hunt for a buyer. That move came just weeks after Sunoco said it plans to sell its Philadelphia and Marcus Hook refineries.
As a result, heating oil differentials in the USAC rose to a three-month high this week at the NYMEX November heating oil contact minus 45 points/gal.
At the same time, the NYMEX front-month heating oil crack spread against ICE Brent was around $14/b, about $2/b from the same week in 2010, reflecting tighter supplies as the market heads toward peak heating season.
Heating oil stocks on the USAC have fallen 924,000 barrels to 31.488 million barrels between September 2 and September 30, according to EIA data.
Amid the loss of capacity, differentials were also pressured higher by a surge in exports to Europe, refinery issues at other USAC operations, and a reduction of resupply arriving on the Colonial Pipeline, which runs from Houston to New York.
Analysts said the US Gulf Coast could make up for the loss of refining capacity on the USAC, but other sources said the Colonial Pipeline remains the key supplier to the USAC region and is already stretched near its limits, which will add further tightness to heating oil supplies in the northeast.
With the greater reliance likely will come greater price volatility, market sources said, since the volume of distillates arriving into the Linden, New Jersey, terminus varies greatly from cycle to cycle.
Shippers have opted to push more ULSD and jet fuel up the Colonial line, rather than heating oil. Accordingly, the differentials on those two products fell last week.
But heating oil's movement is more revealing of the actual fundamentals, sources said, than are those of ULSD and jet, partly due to actions of the futures market which has a greater propensity to reflect the state of supply and demand.
