|
Tuesday, July 13, 2004
'Crazy' oil prices deal Mainers a challenge
Copyright © 2004 Blethen Maine Newspapers Inc. | ||||||
 |
||||||
At 10 a.m. last Thursday, the computer screen in Alan Dorr's office showed that the contract price for heating oil to be delivered next month in New York Harbor was $1.09 a gallon. An hour later, it had dropped to $1.05. Late in the day, it had topped $1.10. Not long ago, it would have been noteworthy when wholesale oil prices on the New York Mercantile Exchange moved a penny in a day. But Dorr, who buys oil for Dead River Co. in Portland, isn't surprised now to see big price swings in the commodities market. This price volatility that Maine oil dealers are coping with in the heat of summer highlights an especially challenging year to line up supplies to meet customer demands this winter. Ten or so years ago, the price of heating oil in July didn't matter much. It does today, for both dealers and customers, because summer market conditions for heating oil are as high priced and volatile as most anyone can remember. Oil is the dominant heating fuel in Maine, and about half of the 400,000 households that are warmed with oil sign up for a price protection plan. These plans allow customers to lock in or cap the price of oil that will be delivered this winter. To make certain these contracts can be honored in January, dealers need to secure millions of gallons of oil this spring and summer. In a highly competitive market, they also need to give their plan customers the best prices possible, and still make a profit. Dealers say this process has become especially complex and challenging this year. "The volatility is absolutely nuts," said John Peters, president of Downeast Energy. "Prices can go crazy now within a day, moving 5 to 6 cents. So think about buying price protection eight months out. That's the problem the dealer faces." In recent years, some dealers were stung when they signed up customers for price protection plans, but held off on purchasing adequate supplies. They gambled that wholesale prices would drop. When that didn't happen, they either lost money or had to tell angry customers that they couldn't honor their contracts. Major dealers such as Dead River and Downeast Energy say they can't take that risk. They make sure every pre-bought gallon is covered. "You have to buy everything you're going to pre-sell," Peters said. Heating oil prices should have fallen to low levels by now, as they generally do at this time of year. They haven't. The average retail price around Portland last week was $1.39 a gallon, according to Maineoil.com, a Web site that monitors oil prices. By comparison, the average price was $1.12 at this time last year. For the entire heating season last year, Maineoil.com figures show, a gallon of oil averaged $1.27. So prices are already elevated this year, well before the first frost. That's making price-protection plans more popular than ever, and has sent dealers hurrying to sign up customers and cover their supplies. The typical Maine home burns 800 or so gallons of oil a year. Price protection plans are aimed at customers who need their tanks filled more than a couple of times a winter and have signed up for automatic delivery. TWO GENERAL FORMS The plans come in two general forms - fixed-price purchases and price caps - although there are variations on these themes. A price-cap plan sets an upper limit for what oil will cost per gallon next winter, no matter how high the market goes. If prices drop, customers get the lowest cash price. Some larger dealers offer a payment option for their price-cap plans. They spread the charge over 10 or so monthly payments, and even pay interest on any balance. Fixed-price contracts, as the name implies, provide oil at a fixed price. This is the cheapest way for customers to lock in a discount and the per-gallon price tends to be a dime or so below the cap prices. In Portland, dealers were generally offering a fixed rate between $1.45 and $1.50 a gallon last week. That could be a bargain this winter, if the weather's cold and prices shoot up when the tank needs a refill. Or it could be a miscalculation, if global oil production overtakes demand and prices slide. "Volatility doesn't affect the seller or the buyer in this case," Peters said, "except we may have a public relations problem if the price falls." Either way, dealers buy these gallons ahead of time from their suppliers. But they also protect their investments by buying and selling commodity options that act as an insurance policy. One way is to purchase "wet barrels," actual oil for future delivery at a fixed price from a specific supplier. The cost to the dealer is based on the prices set for future delivery, say, in January. At Dead River, Dorr also buys "paper barrels," another form of futures contracts on the mercantile exchange. Paper barrels give dealers more flexibility because they can be sold. With wet barrels, dealers need to take delivery. Say a customer needs 1,000 gallons in January. The futures price last Thursday for oil delivered in January was $1.12 a gallon, a price that doesn't include transportation, terminal fees and other costs. Dorr will buy a paper contract at the mercantile exchange for the right to buy 1,000 gallons at that price in January. Because each contract is in 42,000-gallon increments, many customer plans are added together. Come January, the current or "spot" wholesale price of oil could rise to, say, $1.20. So Dorr can sell that paper contract back to the market for $1.20, making 8 cents - on paper, at least. But then he needs to actually buy 1,000 gallons of real oil that the truck can deliver to the customer. That wet product will cost $1.20, erasing the 8-cent paper gain. PRICES COULD DROP It's also possible prices will drop in January. If the wholesale price falls to $1 in January, Dorr will need to sell his $1.12-a-gallon paper contract for a 12-cent loss. On the other hand, oil on the spot market will be selling at $1, so he can make up the loss and still provide the 1,000 gallons for the fixed price Dead River agreed to honor for the customer. Things get even more complicated when dealers buy oil to cover price-cap plans. Because these plans give customers any current price that is below the cap, dealers need to cover themselves if prices fall. In this case, they buy options on the mercantile exchange. Options give dealers the right - but not an obligation - to buy or sell oil at a specific price and date in the future. The price of an option is called a premium, and the volatile oil market has helped send premiums to levels roughly twice as high as normal. For instance, oil for delivery in New York Harbor in January was priced last week at $1.10. But due to the volatility of the market, it costs 10 cents more today for the right to buy it. Essentially, this $1.10 oil will cost Dorr $1.20. This dime premium is passed on to consumers who purchase price protection plans. If prices fall to $1, Dorr will let the option expire. He doesn't want to buy at $1.10. But he and his customers still wind up paying that extra dime for the premium, which is like paying a premium for insurance. "With caps," Dorr said, "there's no windfall for the company. With cap prices, we're just locking everything in. The cap covers our cost, the premium and the right to buy at a certain price." 'STIFF COMPETITION' Dorr agreed that most customers don't realize the extent that dealers are going through these days to offer price protection deals. "They know what the cap means to them," he said. "I don't know if they understand how we're doing it." Adding to the volatility of oil prices is the trend of investors unconnected with the energy business to speculate on the daily rise and fall of these premiums. These hedge funds distort prices, some oil dealers complain. A wave of purchases by hedge fund managers, as well as government announcements concerning terrorism threats, helped push oil prices up last Thursday, according to analysts. At first glance, higher oil prices might seem like a good thing for dealers. But Maine dealers say refiners and producers benefit most from higher prices, not dealers, who are essentially middlemen. That's especially true in Maine, which has a very competitive heating oil market characterized by small, low-overhead dealers who try to undercut the big players. "This year the competition is very stiff," said Mark Cyr, retail sales manager at C.N. Brown. "It's at a point where our profit margins on pre-buy and cap plans are less than in past years." Because wholesale oil prices are so high this year, Cyr said, there's not as much of a spread between his costs and retail prices. C.N. Brown was offering a fixed price plan in Portland last week for $1.45 and a cap plan for $1.55. Those prices aren't much different from last year, Cyr said, compared to the run-up in retail petroleum prices that is evident to anyone who fills their car with gasoline. "It's going to be the tightest winter in about four years for profits," he said. The abrupt price changes last Thursday morning appeared to be tied in part to the release of a weekly report from the American Petroleum Institute. At Dead River, Dorr flipped his computer screen to a table of numbers showing that "distillate inventories," basically heating oil and diesel supplies, had taken a big, unexpected jump. Later in the afternoon, the price had shot back up, topping $1.10 a gallon. For Maine oil dealers, it was just another day of wide swings in a petroleum market buffeted by the war in Iraq, fears of terrorism, hedge fund speculators and the normal forces of supply and demand. Staff Writer Tux Turkel can be contacted at 791-6462 or at:
|
||||||
