Energy prices were weak on Monday - Natural gas futures dropped like a rock after last week’s (freeze off) rumor buying segued into fact selling. Meanwhile crude oil and the products hit higher highs but closed lower on mostly sideways trading. We expect more of the same until tomorrow’s DOE release.
This winter’s frigid temps in the U.S. have pushed up heating Btus on the NYMEX… rightly so, after all, high seasonal demand should equal high prices. Consider the forward curve for the NYMEX heating oil contract through the winter and you notice not just an absolute increase in prices, but a relative gain in the front month spread.
In a well supplied consumption commodity market, such as the market in the U.S. for distillate fuels, we expect prices out in the future to be higher due to storage costs and market uncertainty. In the short term, front month prices rise if there are concerns supply will not meet high seasonal demand.
There is also a relationship between the crack market and the term structure. In today’s issue of The Schork Reportwe note, however, that this relationship has broken down recently.
Therefore, on one hand we have a sharp flattening of the NYMEX heating oil forward curve. That is not hard to comprehend… according to the API, approximately 2 in 5 gallons of refining capacity in the East (PADD I), the largest residential heating oil market in the U.S., is idle.
In turn, strong weather related demand and low throughput led to the first >6 MMbbl draw in the month of December for PADD I heating oil supplies (>0.05%) since 1999. More importantly, we are just now entering what is historically the coldest part of the winter, i.e. the month following the winter solstice.
The latest forecasts we see are calling for a brief warm-up in the next week or so, but the cold is expected to return towards the end of this month, beginning of next.
The flattening in the structure of the NYMEX heating oil curve is a function of its “convenience yield”. The convenience yield, as Dr. John Hull describes it “… reflects the market’s expectations concerning the future availability of the commodity.”
While the notion of a shortage in PADD I heating oil supplies appear absurd, the contraction in the forward curve on the NYMEX suggests otherwise. That is to say, the possibility of a shortage through the remaining life of the NYMEX winter contracts has been priced into the market.
On the other hand, refiners still cannot make any real money cracking distillates. As we illustrate in today’s issue of The Schork Report, as of last night NYMEX heating oil for March delivery (the last heating oil contract of this winter) was yielding only 11% to WTI. If we omit last year owing to the collapse in WTI, this crack is yielding around 6½ points below the 2003-2007 timestep.
In other words, this lack of margin for refiners fails to confirm the fundamental bullish signal the NYMEX heating oil curve is currently emitting.
Stephen Schork is the Editor of, and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.