Heating-fuel customers placing bets

Two years ago, Fred Schumacher locked in a price for heating oil, and he was glad he did. As prices rose in the fall, the cost of heating his King of Prussia home stayed put.

Last year, the same strategy left Schumacher feeling burned - not by high heating-oil prices, but by low ones. He agreed to pay $2.59 a gallon. Then he watched in frustration as prices fell as much as 30 cents. So this year, he avoided a lock-in.

That's how it goes for heating-oil customers. Unlike those who heat with natural gas or electricity, oil customers get up close and personal each year with the vicissitudes of the commodities markets. Like professional traders, they pay their money and take their chances.

Schumacher, a retired Unisys Corp. engineer, is philosophical about the annual quandary. "Some years the bear eats you," he says. "Some years you eat the bear."

This year, the trends that could affect heating-oil prices seem particularly tough to parse, even for experts: Imported oil topping $80 a barrel. Mild fall weather in the Northeast. A falling dollar. Worries about energy-price speculation.

Philadelphia-area heating-oil prices have risen modestly since summer, typically into the $2.60s and $2.70s, from a statewide average of $2.43 in July. Prices are up even more from a year ago, when nationwide prices averaged $2.30.

With spot-market wholesale prices topping $2.20 on Friday, consumers should expect retail prices above $2.80, according to Mary Novak, an energy analyst at Global Insight, the Boston economics-forecasting firm.

What comes next? That's the $2,000 question for oil-heat customers, who typically buy about 650 to 1,000 gallons of fuel each winter.

It's a question that affects hundreds of thousands of people in the Philadelphia region, especially outside the city. In Bucks and Chester Counties, more than a third of all homes are heated with oil.

Last month, a group concerned about consumers' growing difficulty paying for heat drew headlines with a prediction that heating-oil prices would jump 28 percent this winter, to an average of $3.10 a gallon.

The National Energy Assistance Directors Association, which is fighting a Bush administration plan to cut this winter's funding for the Low-Income Home Energy Assistance Program, based its projection on last month's climb in crude-oil prices.

"We all hope that prices will drop, but this is a very volatile market, and we just don't know," said Mark Wolfe, the group's executive director. "Families should be prepared. Right now, oil is in the $80 range, and if it stays there, this is what could happen."

Tomorrow, the U.S. Energy Information Administration will issue its annual forecast of winter fuel prices. It may well project a smaller rise than Wolfe does in heating-oil prices, but some bad news is likely. When oil was closer to $70 a barrel last month, the EIA was already predicting that heating-oil prices would rise 30 cents a gallon over last year, to an average of $2.78 - on an inflation-adjusted basis, higher than any time since 1981.

"If crude oil prices stay above $70, that's very likely to affect heating-oil prices," said Neil Gamson, an economist who helps prepare the EIA's short-term forecasts. (For more information, go to www.eia.doe.gov.)

Others see the near future differently.

Novak says Global Insight is predicting a softening of the heating-oil market, echoing last year's trend, with wholesale prices dropping to $2.05 in the fourth quarter and $1.98 in the first quarter of 2008. That means retail prices should drop to an average of $2.58 before spring, she said.

Why?

One reason obvious to Novak is the unseasonably mild start to the heating season in the Northeast, the only U.S. region that relies heavily on heating oil.

"We've had 80 degrees in the afternoon for the last two weeks, and 55 to 60 at night, so nobody is running any heat," Novak said. "All we're doing is building stock."

Novak said mild weather magnifies the effect of solid inventories, which are high compared with five-year averages. If the Northeast's mild weather continues through mid-December, which the National Weather Service has said is likely, prices should stay fairly soft.

"The thing that really spikes heating-oil prices are early cold spells, in October or November, because that makes people nervous that we won't have enough inventory to last till the end of February," Novak said.

Along with consumers, oil dealers struggle to cope with confusing price trends. When prices drop noticeably, it's not easy to deliver oil to a customer with a locked-in price. That's what happened last year to Schumacher.

"They were delivering for $2.39 and $2.29, and I was grinding my teeth," he said.

For the last four years, Collingdale's Dave Hanly Oil has offered a locked-in price. Not this year.

"I decided my customers would be better off without it," said owner Dan Hanly, the founder's son.

As small, typically family-run businesses - Dave Hanly Oil serves about 1,600 customers in and near Delaware County - oil dealers generally can't afford to bear the risk of a locked-in price. Instead, they sign a contract with a refiner or wholesaler to cover the position. In essence, they're locked in, too.

Hanly said customers usually have accepted his explanation, even if it is comparable to paying $3 a gallon at a gas station with a posted price of $2.70.

"Most customers understood that I purchased oil on their behalf," he said. "They pretty much had to grin and bear it. That's the chance you take with a lock-in."

This year, Schumacher opted for a different approach: a price cap. He prepaid for 1,000 gallons at $2.49 from a Plymouth Meeting dealer. If prices rise, he's protected. If they fall, he'll recoup the differential in extra fuel.

Dealers have their own complaints, many centering on what's happening in world oil markets, where futures prices have been buoyed by speculation by major financial institutions. In essence, the institutions are betting that prices will rise, which critics call a self-fulfilling prophecy.

Eric DeGesero, executive vice president of Fuel Merchants Association of New Jersey, said speculation in futures contracts also has led to larger price swings. Those swings have a direct impact on consumers, by increasing the cost of buying a season-long price guarantee, he said.

"One issue over the last couple years is the cost of buying that type of insurance has gone from 2 cents a gallon to 18 or 20 cents a gallon," he said. "That cap is insurance in the market, and prices have become more volatile."

DeGesero said his group had urged lawmakers to require oversight of energy-derivative markets that parallel traditional futures markets but are largely unregulated.

"They are symbolic of the Wild West nature of how trading is conducted today. Consumers and the economy as a whole are paying for it," he said.

Percent of dwellings, by county, in 2004.

Chester             36

Bucks               34

Montgomery     29

Delaware          23

Gloucester        22

Camden           18

Burlington         16

Philadelphia       8

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