Heating Oil Price Gouging?
By Peter K. Ashton
Innovation &
Information Consultants, Inc.
Concord, MA 01742
As the
winter heating season is now fully upon us, prices seem to be rising as
quickly as the temperature is falling. The key question, however, is
whether these price increases are being driven by competitive market
mechanisms – supply and demand – or by some other means of
control? There is little doubt that heating oil prices tend to rise in
winter and decline in spring and summer – demand for heating oil peaks
in January and February when the weather is coldest and consumption is at its
peak. However, given sufficient supplies and inventories of heating oil,
one should not expect increases in heating oil prices that are out of line
with market fundamentals. Yet recent price data suggest that heating
oil prices have recently risen twice as rapidly as market fundamentals might suggest.
First, no one is claiming that there is a shortage of heating oil or that the
cold weather we are facing will cause a shortage. Stocks of heating oil
in the Northeast entering this year’s heating season were 10 percent
higher this year than last year. Inventories appear more than
sufficient to meet expected demand, particularly since the month of December
was extremely warm and consumption of heating oil was down relative to a
“normal” month of December.
Second, crude oil prices, the single most important determinant of heating
oil (and other refined product prices such as motor gasoline) are up relative
to price levels last year. The price of West Texas Intermediate (WTI),
a bellwether crude oil produced in the United States, is up about $1.60 per barrel or
less than 4 cents per gallon relative to last year’s levels.
Brent, a North Sea crude oil that perhaps better
dictates prices in the Northeast, is up only $0.60 per barrel or less than 2
cents per gallon from last year’s levels. At the same time motor
gasoline prices in Massachusetts are up approximately 4 cents per
gallon relative to last year – the result of higher crude oil prices
and other slightly higher costs of processing. Heating oil prices,
however, are up 7 cents per gallon relative to last year, almost double the
increase seen in motor gasoline prices and far more than is justified by
either crude oil cost increases or supply-demand factors. Indications
are that heating oil prices will continue to rise in the ensuing weeks as the
drop in temperatures provides suppliers with a convenient excuse to increase
prices at consumers’ expense.
The ability of homeowners to shift between sources of heating fuel is
extremely limited and thus consumers face what economists call highly
“price inelastic demand” – as prices move upward, consumers
have little or no option but to pay the high price and use about the same
amount (we all turn the thermostat back a little, but we’ve been doing
that for years, so it makes little difference in terms of consumption).
The suppliers (typically the refiners and wholesalers, not the heating oil
dealers themselves) recognize this phenomenon and are able to take advantage
of it, reaping additional profits as the weather gets cold. Consumers,
many of them on fixed incomes, have little or no choice but to pay the higher
prices.
Finally,
this phenomenon is not terribly different than what consumers have witnessed
repeatedly in recent years with motor gasoline price spikes when the summer
driving season peaks: inventories begin to be drawn down and the major
refiners increase prices quickly to take advantage of the situation.
They may blame refinery shutdowns, supply disruptions and the like, but the
issue remains that market fundamentals – supply and demand –
simply do not explain the observed price spikes
Endnote
1See my
testimony before the Senate Permanent Subcommittee on Investigations,
“Gas Prices: How are They Really Set?” May 2002.
