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Drop in energy prices may be short-lived

The recent skid in oil prices is giving consumers a welcome break from higher heating oil and gasoline prices. But analysts say the reprieve may be only temporary. By's John W. Schoen
Man prepares to deliver heating oil to a house in Alexandria
While still higher than last year, the retail price of a gallon of heating fuel has dropped 45 cents from a high of $2.64 last fall. Joshua Roberts / Reuters file
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The recent skid in oil prices is giving consumers a welcome break from higher heating oil and gasoline prices. But analysts say the reprieve may be only temporary.

Though the groundhog has predicted plenty of cold weather ahead this winter, heating oil prices have likely peaked for the season. While still higher than last year, the retail price of heating fuel has dropped 45 cents a gallon from a high of $2.64 last fall.

One big reason: falling crude prices have cut the cost of refining heating oil. And despite the recent cold snap throughout much of the country, it’s been a warmer winter than expected.

As a result, heating oil inventories are running about a third higher than this time last year, according to Jacques Rousseau, an oil industry analyst Friedman, Billings, Ramsey. That means the markets should be adequately supplied for the rest of the winter.

Natural gas prices have also fallen nearly a half from a high of more than $16 per thousand cubic feet in December. The relatively mild weather to date has left the natural gas industry with ample supplies in storage -- about a third higher than the 5-year average for this time of year. That means consumers have likely seen the worst of natural gas prices for this winter's heating season.

Drivers are also getting a break at the pumps. With most hurricane-damaged refining capacity back online, and gasoline demand down a bit, retail gasoline prices have settled back to about where they were this time last year. The average pump price for regular gasoline has fallen by a third from a high of $3.12 a gallon last September.

After last fall’s hurricane-related shortages brought a wave of imported gasoline to U.S. dealers, supplies are now well above their 5-year average for this time of year and rose again last week, according to the Energy Information Administration. That buildup of inventories may help send prices even lower this winter, according top Tom Kloza, publisher of the Oil Price Information Service.

"Half of the country is going to see probably prices below $2 at the pump in the next couple of weeks," he said. "You’ll hear people going, ‘Wow, I got gasoline for $1.89 or $1.99 – like it’s such a deal."

A lot depends on whether oil traders continue to pound away at the price of crude oil, which accounts for about half of the price of a gallon of gasoline. Crude oil prices fell below $60 a barrel Tuesday.

Higher-than-normal crude inventories could push oil prices even lower. Weekly figures posted Wednesday by the U.S. Energy Department show oil stocks rising for the seventh straight week to their highest levels since last June. Crude oil inventories are nearly 11 percent above year-ago levels.

The drop in crude prices also comes amid a lull in potential threats to oil supplies from major producers. Fighting in Nigeria has subsided, tensions over Iran’s nuclear ambitions have eased a bit. And the added buildup of supplies has given the oil markets a bit of a cushion against possible supply cutoffs. On Tuesday, for example, the head of the International Energy Agency said its member governments have built up strategic reserves to cover a possible shutdown of Iranian crude output for up to 18 months.

But with little spare capacity in global production, and much of the world’s oil coming from politically unstable regions of the world, worries about supply interruptions remain a major factor in keeping oil prices high. Analysts say the recent buildup of crude inventories could be drawn down quickly if a major bottleneck develops.

Gasoline bottlenecks?
Bottlenecks may also be looming for U.S. gasoline supplies, which could make the recent drop in pump prices only a temporary reprieve.

"This is a bipolar market," said Kloza. "We’re in probably the advance stages of one of the more depressive phases, but I think the manic phase is going to follow in the second and third quarter of this year."

What will drive prices back up again? For starters, demand typically rises in summer, which will add upward pressure on prices.

There are also several potential bottlenecks that could put a crimp in gasoline supplies. Though most refiners damaged by hurricanes Katrina and Rita are now back on line, the rest of the industry was forced to postpone routine maintenance to keep the markets supplied. As those refiners begin to go offline to take care of maintenance and repairs, that lost production could tighten supplies.

Gasoline stocks could also get tighter as dealers in many parts of the country switch to so-called reformulated blends for summer, which are required to make fuel burn cleaner and prevent smog. Until recently, that meant using a fuel additive called MTBE. But after the chemical was found seeping into groundwater, and chemical makers failed to win liability protection in last year’s Energy Policy Act, most refiners have stopped using MTBE. The only available substitute is ethanol, which is more costly.

Though gasoline demand has fallen steadily in the recent weeks, it’s not clear whether that drop represents a long-term shift change in driving habits. Many drivers, especially those with tight household budgets, have cut spending in other areas to keep up with pump prices. But the overall impact on demand has been limited, said Rousseau.

"(Consumers with) the lowest 20 percent of income are only using 9 percent of gasoline," he said. "So they’re not moving the needle as much as other people -- who won’t change their patterns no matter what the price is."

At some point, higher pump prices could produce a more permanent cut into demand, especially if new car buyers shift to models with higher fuel mileage. But with 230 million cars and light trucks on the road in the U.S., the impact of higher efficiency vehicles won’t show up in gasoline consumption for years, analysts say.