Heating oil futures rising on very tight distillate market

Heating oil futures are up 5.4% on the week, and 20.1% on the month, as the seasonal pre-winter buying is beginning to pick up and is met by lower than usual distillate fuel oil inventories in the US, Europe and Singapore.

The recent rise in the underlying crude oil prices is also providing support with WTI trading at $79.7 a barrel and Brent crude just shy of $84/bbl.

The current tightness in supplies of what is called middle distillates (diesel, heating oil and kerosene) has registered with money managers and hedge funds and other investors who have increased their combined positions in eight of the most recent 10 weeks. Their positions are up by 76 million barrels since May 2, both in the US and Europe.

Tightness likely to last into the winter

A smaller and less liquid futures contract than crude oil, heating oil is still closely related to crude. Like diesel, a related oil product, more than 40% of its price stems from crude oil and another 18% from refining costs.

As it is used for heating, prices in the northern hemisphere normally start to pick up in June, their rise speeds up between August and November and then they begin to turn lower in December, reaching the lowest point around March.

This year’s period of rising demand is coinciding with U.S. inventories being at their lowest level in almost 20 years. According to the US energy agency EIA distillate fuel oil inventories (held in refineries, pipelines, storage facilities and terminals) amounted to only 118 million barrels in mid-July, or 15% lower than the previous ten-year average.

Distillate stocks at lowest levels since 2004

Although distillate stocks have increased slightly from last year when they were just 113 million barrels, they otherwise remain at the lowest level for this time of year since 2004.

A similar supply picture last year resulted in residential heating oil prices rising 70% compared with 2021 although the situation then was exacerbated by the US rerouting some of its supplies from domestic markets into Europe markets which were paying a much higher premium because of the shortage created by the conflict in Ukraine.

While buyers and suppliers have found ways to replenish the gap created by Russian oil supplies the tightness in middle distillates is still present.

Reuters commentator John Kemp noted that there is not much scope for rebuilding depleted diesel stocks by running refineries harder as US refineries are already operating at a rate of 94.3%, the highest since 2015.

Shifting stocks away from producing gasoline or drawing down diesel inventories in other regions of the world is also not an option. US gasoline stocks are also depleted, making it difficult to boost diesel yields at their expense. In Europe, distillate inventories are 30 million barrels, or 7% below the seasonal average while the deficit in Singapore is 3m barrels, or 27% below.

In recent decades, inventories have normally been reset after a period of depletion by a mid-cycle slowdown or a cycle-ending recession, but so far the slowdown has not been deep enough to rebuild them, notes Kemp.

After this scorching summer, it could be an interesting winter, particularly if the weather turns extreme.

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