By John W. Schoen Senior producer
updated 8/18/2008 7:47:36 AM ET 2008-08-18T11:47:36

Though pump prices have eased off a bit, energy prices are still a major budget buster for many households. In cold weather states, this is shaping up to be an expensive winter. But no one knows for sure just where heating bills will end up. So is it a good idea to sign up for one of those pre-paid heating plans? Or hope that oil prices will keep falling?

Do you think it’s a good idea to lock into a pre-pay plan for heating oil this winter? We made out OK last year (easy winter in Pennsylvania) but the year before the price dropped and we were stuck paying the higher price. I thought we should pre-pay this year when the price per barrel was rising but now it's dropping and I see gas dropping but will it really affect the heating oil? We have to decide by the end of August.
Deb M. Boyertown, Penn.

If you’re asking whether or not we can forecast heating oil prices six months in advance, the answer is: We haven’t got a clue. No one does. These days, there are just too many variables.

The most important, of course, is the weather: Will mild weather ease demand for heating oil — or will a cold snap tighten supplies? (For what it’s worth, the U.S. Weather Service seems to think we’re headed for a somewhat milder-than-normal winter. The Farmer’s Almanac predicts that, where you live, “winter will be one to two degrees above normal, on average, with especially mild temperatures in November and March.” )

But winter temperatures are only one variable pushing heating oil prices up and down. Will demand for crude oil continue to ease, bringing crude prices lower? Or will the price of oil go back up again if shooting starts in a part of the world where oil is produced? Will U.S. oil producers and refiners in the Gulf Coast dodge this year’s hurricane bullets before winter sets in? How well will refiners, both here and abroad, fare in keeping output high enough and building big enough stockpiles of heating oil to get through the winter?

Welcome to the world of oil speculation. In recent years, the volatility of oil prices — and the resulting gyrations in the prices of products made from oil — has attracted billions of dollars of investment from “speculators” who think they know the right answer. Some readers — and a few members of Congress — have suggested that banning speculation would help tamp down that volatility. But the reason these futures markets were created in the first place was to help folks like you who want to dodge the risk that prices may spike this winter. In return, you may end up “overpaying” if prices fall lower than the price you pay. But you’re still getting your money’s worth.

The earliest trading in commodity futures was set up to help farmers navigate the boom and bust of a business heavily dependent on the unpredictability of the weather. Otherwise, they’d always be just one bad crop away from financial ruin, with nothing to pay for planting next year’s crop, let alone enough to get through the winter.

This year, a lot of farmers took advantage of the futures markets to lock in both the price they get for their harvest, in some cases before the seed had sprouted, and the cost of fuel to operate their machinery. If grain prices surge again before the last harvest, they may have “lost” money. But they locked in a guaranteed profit.

That guarantee comes at a price: Think of it like an insurance premium. The buyer who agreed on a price last winter for this summer’s harvest was taking a risk. Those buyers can (and many do) lose money. But if they bet right, they’ll earn a profit on every bushel without spending hours riding a combine. By making enough side bets, they can further reduce their own risk of losing everything.

Heating oil futures aren’t much different. If you lock in a price today, and prices fall, you may be “stuck” paying the higher price. But the extra money you paid represents something of real value: The peace of mind you get from knowing that you won’t get hit with an even higher price.

You may be wondering who gets that “extra” money; it’s probably not the oil dealer who sends you the bill. Many dealers have given up offering fixed-price contracts before the season begins. Those who do are most likely buying their own futures contracts to lay off the risk on someone else. Chances are, your dealer will hedge his contract with you before the first frost. (If you’re curious, just ask.)

Heating oil prices may well drop again from current levels — or they may go higher. If you can’t afford the cost of a big price spike, taking out a little “price insurance” today isn’t such a bad idea.

For years, diesel was the stinky, bottom of the storage tank, left-over dregs, that fueled our semis and buses across the country. When the Big Three auto makers started making pickups with good quality diesel engines in them, the price of diesel jumped by leaps and bounds to surpass the price of gas. Why?! Diesel is still easier and cheaper to make than gas, yet the price has remained way beyond the price of gas.
William F. Pawnee, Ill.

Let me stop you at “the stinky, bottom of the storage tank, left-over dregs.”

While that may have been true in the good old days, as of last June refiners were required to make (and new diesel engines have to run on) what’s call Ultra Low Sulfur Diesel. That old diesel did more than stink: It had an unacceptable level of what are called particulates. Because it was not refined as purely as gasoline, those impurities went out the tailpipe into the atmosphere and eventually settled in people’s lungs.

The transition to these new standards took years — and billions of dollars in refinery upgrades. Some refiners made the business decision that the cost of upgrading was too great to justify. (Or, as many readers believe, they conspired to shut down capacity as part of a national price gouging conspiracy — take your pick.) So we now have cleaner diesel, but it’s no longer the poor stepchild of the refining process.

There’s another reason gasoline and diesel don’t march to exactly the same drummer. Refined motor fuels — while mostly produced as close to market as practical — are still a global commodity. About 10 percent of the gasoline sold in the U.S. is imported. In this country, overall consumption skews toward gasoline; relatively few passenger cars here use diesel.

In Europe, the reverse is true, and the high-mileage diesel fleet is growing. That has produced increased demand globally for diesel (along with the agricultural and construction industry demands of developing countries.) So what used to be a relative “surplus” of diesel in the U.S. has now been eliminated by foreign demand.

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