Heating oil is a low-viscosity liquid petroleum used to heat homes all over the world. Also known as No. 2 oil – heating oil is delivered to homes by tanker trucks and stored in storage tanks located in basements or below ground. Prior to 1885 most homes in America were heated using wood-burning brick fireplaces. In the early 19th century coal began to over-take wood-burning fireplaces as the primary method for heating homes.
It was not until 1935 with the invention of the forced air furnace that heating oil became a commonplace fuel used to heat American homes.
How is Heating Oil Created?
Heating oil is very similar to diesel fuel and is comprised of a mixture of petroleum-derived hydrocarbons. It is created through a distillation process in which petroleum is separated into its individual component parts. Distillation often takes place at a petroleum refinery where the process is run in a steady state.
While most petroleum products condense at temperatures between 644 and 752 degrees Fahrenheit, heating oil condenses at lower temperature ranging between 482 and 662 degrees Fahrenheit.
The Economics of Heating Oil
Heating oil is traded on both the NYMEX and the Intercontinental Exchange (ICE) and oftentimes used to hedge jet and diesel fuel. As demand for heating oil wanes during the summer months, refinery output of heating oil decreases. As demand decreases as do prices and trading is far less volatile during Q2 as more focus is put on gasoline.
Given the current state of the US economy it should come as no surprise that heating oil prices would dip lower than usual as consumer spending continues to decrease. Weather plays a pivotal role in the demand for heating oil and harsh winters obviously create greater demand.
Heating Oil and Crude Oil
While heating oil and crude oil do follow different seasonal trends their prices are still directly related. Since heating oil is derived from crude oil, increases in crude oil prices will in-turn increase heating oil prices. As demand for crude oil grows, the price of both gasoline and heating oil will increase.
Only 7% of U.S. households use heating oil and this usage is mostly concentrated in the Northeast. Shipping costs play a crucial part in this regional distribution as the consumer price for heating oil is also related to the shipping distance.
In 2008 heating oil prices were quite high due to the record-high crude oil prices found during the summer months. It is important to note that heating oil and diesel are also closely related as both distillates are generally made together during the refining process.
As you can see from the chart above, distillate production has continued to increase over time, driving the price of heating oil up. As production begins to ramp-up in the second half of the year more diesel fuel will be needed for shipping and transportation which in turn will provide for greater heating oil production.
This year, however, heating oil reserves were roughly 18% below their normal levels as high-demand for diesel fuel favored distillation of a larger percentage of diesel than heating fuel in order to meet growing demand.