October 27, 2010
(Next Release on November 3, 2010)

A Tale of Two Markets: Natural Gas and Residual Fuel Oil

The relationship between natural gas and residual fuel prices is of particular interest to the electric power and other boiler-fuel markets in which these two fuels compete. Some facilities in the electric power industry and some boiler use in the industrial and commercial sectors have the ability to switch between these fuels, based on their relative economics at a given time. However, not all electric power and other boiler-fuel users can switch fuels in the short term; for example, some do not have access to natural gas. Historically, shifts in the relationship between natural gas and residual fuel prices have occurred (Figure 1). While their prices were relatively close in the second half of the 1990’s, natural gas developed a premium in 2000 as markets for natural gas tightened at a faster pace than residual fuel oil. But in 2007, a significant reversal occurred, with residual fuel trading at a large premium to natural gas.

      Source:   Thomson Reuters.
      Note:   Btu = Britsh thermal unit.

The spread dynamic became pronounced when crude oil and refined product prices started to march upward in 2007. This coincided with the beginning of a shift in the supply of U.S. natural gas driven by the rapid growth in shale gas production. From 2007 to 2009, annual marketed natural gas production in the United States increased at an average annual rate of 4.1 percent, compared to a decline rate averaging 0.6 per cent per year over the first six years of the decade. As a result, the domestic natural gas market has become increasingly well supplied leading to softer prices.

In the last few years, residual fuel oil prices have exhibited unusual strength, further widening the price difference and discouraging consumption. Typically, residual fuel sells at a discount to crude oil, but recently that discount has narrowed. Unlike U.S. natural gas prices, international markets have a strong influence on residual fuel prices and associated U.S. demand responses.

Residual fuel sales in the United States declined in the early 1990’s for environmental and economic reasons (Figure 2). From 1995 through 2005, U.S. sales were relatively flat, with transportation use (mainly bunker fuel for shipping) and the electric power sectors each representing about 40 percent of the market. The remaining 20 percent was largely comprised of other boiler-fuel uses in the industrial and commercial sectors, thus implying a boiler-fuel market share of roughly 60 per cent. As residual fuel prices increased both in absolute value and relative to natural gas over the 2006 through 2008 period, total U.S. residual fuel sales fell, declining almost 20 per cent on average relative to the period from 1995 through 2005. Since residual fuel sales for transportation changed very little, the decline occurred mostly in boiler fuel uses, reducing its share from 60 percent of the market to 40 percent on average. End use data for 2009 are not yet available, but total residual product supplied to U.S. consumers remained low in 2009.

While consumption of residual fuel dropped, production did not fall as much, and in the 2008 and 2009 the United States moved from being a net importer of residual fuel oil to a net exporter. High prices for residual fuel oil seemed to be the result of strong consumption from developing economies, in places such as China, Pakistan, and the Middle East, where residual fuel is used for electricity generation and refinery feedstock. It is not clear how long this strength in residual fuel prices will continue. In the longer term, potential changes to sulfur specifications for bunker fuels and environmental concerns will work to reduce consumption of residual fuel oil, while continuing growth in electricity requirements worldwide may could be a source of some growth in consumption.

Retail Gasoline and Diesel Prices Move Lower
After three weeks of upward movement, the U.S. average retail price for a gallon of gasoline fell last week, decreasing more than a penny to $2.82 per gallon. The average was $0.14 per gallon higher than last year at this time. Prices dropped the most in the Midwest, where they were four cents lower than last week. The Gulf Coast had a price decrease comparable to the national average while the East Coast, Rocky Mountain, and West Coast regional prices increased less than penny. The West Coast is the only major region in the country where prices are above the national average, with the average retail gasoline price at $3.08 per gallon.

The retail diesel price was down slightly this week, with the national average dropping less than a penny to stay at $3.07 per gallon, $0.27 higher than last year. Diesel prices also dropped the most in the Midwest, where they were a cent and a half lower than last week. The East Coast and West Coast averages both decreased about a penny. Moving in the other direction, prices on the Gulf Coast experienced a small increase of less than a penny, while prices in the Rocky Mountain region were up almost two cents versus last week.

Residential Heating Fuel Prices Show Minor Movement
Residential heating oil prices increased during the period ending October 25, 2010. The average residential heating oil price gained $0.02 last week to reach $2.99 per gallon, an increase of $0.27 per gallon from the same time last year. Wholesale heating oil prices rose $.02 last week to $2.33 per gallon; $0.18 per gallon more than last year at this time.

The average residential propane price increased, rising $0.01 per gallon to reach $2.42 per gallon. This was an increase of almost $0.27 compared to the $2.16 per gallon average from the same period last year. Wholesale propane prices shrank by about $0.01 to $1.27 per gallon. This was an increase of nearly $0.09 per gallon when compared to the October 26, 2009 price of $1.19 per gallon.

Propane Inventories Build Slightly
U.S. inventories of propane built last week, adding 0.7 million barrels to their total to end at 64.3 million barrels. The bulk of the gain occurred in the East Coast region, with 0.8 million barrels of additional inventories; the Midwest region also added 0.3 million barrels of propane stocks. Gulf Coast stocks drew 0.4 million barrels, while the Rocky Mountain/West Coast stock levels were flat. Propylene non-fuel use inventories represented 3.3 percent of total propane inventories.

Text from the previous editions of This Week In Petroleum is accessible through a link at the top right-hand corner of this page.