FEBRUARY 24, 2000

Increases in Crude Oil, Distillate Fuels and Gasoline Prices

I wish to thank the Committee for the opportunity to testify on behalf of Jay Hakes, Administrator of the Energy Information Administration, who regrets that he was unable to be here today. I will focus on the status of the current crude oil market and its effects on the heating oil, diesel, and gasoline markets and prices. As I will explain, world demand exceeded crude oil production in 1999, largely as a result of the decline in production by the Organization of Petroleum Exporting Countries (OPEC) and several other exporting countries. Inventories were used to meet the excess demand and prices rose in response. Today, world inventory levels are very low, leaving markets vulnerable to price spikes, such as that just experienced in the Northeast.

US Dependence on Petroleum

The United States is still heavily dependent on crude oil, in spite of the growth in use of other fuels like natural gas and coal. In 1998, petroleum supplied 39% of our energy needs. Natural gas and coal were the next largest fuel sources, each supplying 23% of U.S. consumption. Since 1985, domestic crude oil production has been declining while oil product consumption has been increasing, resulting in a growing reliance on imports. In 1998, net imports of crude oil and products supplied about 52% of U.S. petroleum consumption, the highest percentage ever. Transportation is the largest petroleum end use sector, accounting for 65% of petroleum consumed in this country -- mostly in the form of gasoline, which has grown an average of 1.2% per year since 1988. As crude oil prices change, so do petroleum product prices, and because of petroleum's wide use, most of our citizens see and feel the effects immediately.


Crude Oil Market and Recent Price Increases

Crude prices have changed significantly over the past year. Prices rose $18 per barrel (40 cents per gallon) from $12 per barrel in mid February 1999 -- the lowest prices in nominal terms since 1986 -- to over $30 per barrel recently. To put this in perspective, in today's dollars, prices for crude oil peaked in 1981 at about $70 per barrel ($39 per barrel in nominal terms).

Crude oil markets tightened in 1999 as OPEC and several other exporting countries reduced supply, and, at the same time, the recovery of the Asian economies increased demand growth. In 1999, world oil demand exceeded production, and inventories progressively declined. The crude oil shortfall averaged over 1 million barrels per day for the year, reducing world inventories by nearly 400 million barrels. If OPEC were to keep production in the year 2000 at the levels seen in the fourth quarter of 1999, EIA estimates the shortfall in 2000 would be 1-2 million barrels per day.

During 1999, crude oil prices rose faster than product prices, reducing refining margins. The squeeze on margins on top of high crude oil prices encouraged refiners to constrain crude oil purchases, restrict product production, and draw down inventory to meet demand. By the end of 1999, world crude oil and product stocks sank to very low levels. U.S. stocks were no exception. For example, as shown in Figure 1, U.S. distillate inventories, which were ample at the start of the winter season, fell well below normal levels by year end, setting the stage for the heating oil price spike experienced in recent weeks.



Heating Oil Price Spike

Residential heating oil and retail diesel prices (i.e., distillate fuel prices) increased steadily from early in 1999 through the middle of January 2000 largely as a result of increases in crude oil prices. But prices for these products in the Northeast turned sharply upward in the third week of January as shown in Figures 2 and 3. In the three weeks between January 17 and February 7, New England residential heating oil prices rose 78 cents per gallon (66%) from $1.18 to $1.96. In today's dollars, this high price is still lower than the U.S. average heating oil price of $2.45 ($1.29 in nominal terms) that occurred in March 1981. During the same three-week period, New England retail diesel prices rose 68 cents per gallon (47%), from $1.44 to peak at $2.12 per gallon.

While Northeast prices surged, heating oil and distillate product prices in other parts of the country rose very little. For example, heating oil prices in the Midwest rose only 10 cents per gallon during this same three-week period, highlighting the local nature of the problem. Prices are now dropping. Between February 7 and February 14, New England residential heating oil prices fell 32 cents and retail diesel fell 19 cents per gallon. The most recent New England diesel prices for February 21 fell another 19 cents to reach $1.74 -- 38 cents per gallon lower than the peak price. Heating oil prices for February 21 will be available this Friday.

Retail heating oil and diesel fuel prices follow the spot distillate price markets, and crude oil prices have been the main driver behind distillate spot price increases until recently. Figure 4 shows that since mid-January, spot crude oil prices for West Texas Intermediate (WTI) changed very little, but No. 2 heating oil spot prices in the Northeast spiked dramatically. They rose from about 76 cents per gallon in New York Harbor (NYH) on January 14 to peak at $1.77 February 4 before collapsing back to 82 cents per gallon on February 10. Gulf Coast (GC) prices did not spike, but were probably pulled slightly higher as the New York Harbor market began to draw on product from other areas, again indicating the Northeast focus of this problem.

The late-January heating oil and diesel fuel price surges in the Northeast resulted from a combination of low inventories, weather, and supply problems. Low stocks leave little cushion to absorb sudden changes in supply or demand, and increase the possibility of price runups. Distillate stocks fell rapidly in late November through December as high crude oil prices and margin pressure discouraged production. While the trade press attributed some of the inventory decline to movement of stocks from the primary to the secondary level in preparation for Y2K, the early seasonal decline was troublesome. At the beginning of January, East Coast inventories were running almost 4 million barrels or 8 percent below the low end of the normal range.

During the week ending January 21, weather in New England changed abruptly, averaging nearly 20 percent colder than normal for that time of year. The cold weather not only increased demand, but also caused supply problems, with frozen rivers and high winds hindering the arrival of new supply. It was reported that utilities were buying distillate both for peaking power and, along with industrial and commercial users, to substitute for interruptible natural gas supplies, further adding to the market pressure.

Finally, refinery outages at the end of the week sent more buyers into the market. With new supply being delayed and little inventory to cover the increased demand, prices spiked. It generally takes weeks, not days, for new supply to get to the Northeast. The region is now being resupplied, and prices have dropped substantially. Such local market imbalances do not usually last very long.

Upcoming Gasoline Season

The tight crude oil market is also affecting the gasoline market. Gasoline stocks, like other petroleum stocks, are low. Crude oil prices have pushed regular gasoline prices to $1.36 per gallon, the highest level in nominal terms since 1981. We will likely see even higher prices this spring. Refiners will need to increase crude oil runs significantly in March and April to ramp up for the high U.S. gasoline demand season. Typically refineries increase their use of crude oil over 1 million barrels per day during this period. With very little crude oil or gasoline inventory on which to draw, refiners will be purchasing crude oil in a market short on supplies. This extra demand under these circumstances could be enough to cause some gasoline price volatility as we enter the summer driving season.

In Summary

This concludes my testimony. I would be glad to answer any questions that you might have.


Figure 1

Source: Energy Information Administration


Figure 2

Source: Energy Information Administration/State Energy Office Data


Figure 3

Source: Energy Information Administration


Figure 4


Source: Reuters Daily Spot Prices.

Note: WTI -- West Texas Intermediate crude oil price; GC No. 2 -- Gulf Coast No. 2 heating oil; NYH No. 2 -- New York Harbor No. 2 heating oil prices.