When cold is good | FT Alphaville

When cold is good

Recent cold weather in the northern hemisphere may be putting pressure on natural gas and rock-salt supply, but there’s one imbalanced market where the big chill is probably very welcome indeed.

We’re talking here about the refining business and related oil products market. An overhang of distillate stock due to poor demand over the past year put significant pressure on refining margins, leading many facilities to mothball or shutdown capacity.

Luckily for the industry, cold weather stands to increase demand for distillate products like heating oil. The bout of icier than expected climes in January has consequently had a bullish effect on prices. As Stephen Schork of the Schork report explained on Tuesday:

Historically, front month NYMEX heating oil trades at a 1.76% discount in November, while in December only trades at a 1.25% discount as winter demand snaps up supplies. This year saw a similar price path – In October the front month was trading at a 1.7% discount to the second month on the curve, 1.79 to 1.82 respectively. At the start of December this decreased to a 1.2% discount, then 0.9% on the 28th of December and now, as of Friday, January 08th, front month heating oil for February delivery closed at a mere 0.3% discount, 220.03 to 220.69.

That said, there’s still a long way to go before refiners can expect to make sizeable profits cracking distillates.

Schork observed that as of Monday night, the Nymex heating oil contract for March delivery (the last winter deliverable contract) was yielding only 11 per cent to WTI. This is about 6 ½ points below the 2003-2007 average.

Further still, ongoing bullish sentiment in WTI would probably disincentivise refiners from producing heating oil, a fact that could lead to stock drawdowns. While this could be seen as a good thing considering the current mountain of floating storage, the result would not necessarily improve refinery margins, according to Schork. More likely, it would simply flatten the heating oil curve (which is currently in steep contango).

JBC Energy, meanwhile, summed up the situation as follows with reference to the below chart:

It takes much more than a few weeks of cold weather to transform the current fundamentally still extremely weak product/refining market into a balanced one. The chart shows that a cold winter adds an estimated 670,000 b/d of demand in key heating markets over a 4-month period. However, a drawdown of the current stock surplus (both OECD onshore and offshore) would yield 1.4 million b/d of middle distillates over a 4-month period. So even an extremely cold winter throughout April would probably fail to rebalance the product market completely in that time frame.

Related links:

Thank speculators and contango for relatively low heating bills (FT Energy Source)
The GOD (glut of distillate) delusion
– FT Alphaville
Oil, still fundamentally weak
– FT Alphaville
Demand is in the toilet
– FT Alphaville