Calls emerge for reform in wake of speculation that many in Valley are still paying for

Saturday, February 7, 2009

Two years ago, an oil industry expert working for the U.S. Energy Information Administration told the Gazette a variety of factors can influence the price of a gallon of heating oil.

"It's difficult to identify a single reason why the consumer may pay more or less at any given time," the expert told the newspaper in a January 2007 story. "Recently, I think the warm weather has had the most significant effect."

My, how the weather - and the price of a barrel of oil - have changed.

For consumers locked into high, fixed-price heating oil contracts in the Valley, "at any given time" means every month of the heating oil season, which runs September through April.

Today's price for a gallon of heating oil remains in the low $2-range, though thousands of area homeowners are paying more than double that figure, with some heating oil contracts in the Greenfield area close to $5 a gallon this winter.

When prices fell last year, customers stuck in high-price contracts became angry. Oil dealers went on the defensive, doing their best to explain the market madness.

Who is responsible for oil's meteoric rise to $147 a barrel last July and its historic crash to $50 a barrel a mere four months later? And what should be done about it?

In the heating oil business and in Congress, calls are rising for reforms.

Evidence put before Congress this week suggested that a lack of government oversight and deregulation allowed speculators to create an oil market bubble that cost the U.S. more than $110 billion and American households $846 on average.

Along with costing homeowners dearly, the bubble rattled relationships in the local heating oil market, causing recriminations between retailers and their customers.

But the parties that drove prices up, and took profits, it appears, live far from the Valley.

This story seeks to explain, in simple terms, how the oil delivery system operates - and to point to what may be broken.

The dealer's lot

The independent and family-run oil delivery businesses, some four generations deep, are far removed from the machinations of international oil markets.

Apart from their own small-fry trading, local oil dealers wield no control over the manner in which oil prices are set every hour of every business day on the New York Mercantile Exchange and elsewhere.

"We are not highly sophisticated New York Mercantile Exchange traders," said Rick Whiting Jr., owner of Whiting Energy Fuels, in Northampton. "We are essentially truckers trying to provide a service to our customers."

Whiting added that there is little profit from the local dealer's end, particularly at a time when the cost of doing business has risen and access to credit lines tightened.

"You don't see most of us driving around in fancy cars," he said.

But somebody is.

Prices get going

There is mounting evidence to suggest that speculation by traders with no bricks-and-mortar business interests in oil and alleged market manipulation drove the price of oil to unprecedented highs last year. The ensuing market volatility in turn prompted a frenzy of fear, fueled at times by the news media, which misled and damaged businesses, and hurt consumers as a deep recession unfolded.

Consider these headlines from some of the largest newspapers in the Northeast, from New York to Boston, last summer, when homeowners were mulling over fixed-price heating oil contracts many could barely afford:

"People will die this winter because they can't stay warm"

"A grim forecast for heating costs"

"Home energy prices are expected to soar"

These forecasts no doubt swayed many homeowners and businesses to "lock in" prices for the heating season, say those in the industry. Consumer demand, in turn, drove heating oil retailers to enter into fixed-price contracts with their wholesale suppliers.

"There was a lot of talk that crude (oil) was going to go to $200 a barrel," said Mark Skarparas, of Hedge Solutions, a Manchester, N.H.-based consulting firm that helps heating oil distributors minimize risk. "No one knows what's the best time to buy."

A contract is a contract

Four months ago, when the brouhaha over heating oil contracts peaked, leaders from a dozen of New England's heating oil trade associations issued a statement laying out "the facts on fixed-price heating oil contracts."

In short, they outlined a process whereby oil retailers enter into lock-in contracts for the heating season with wholesale suppliers, based on consumer demand. Retailers make price guarantee contracts available to consumers only when they themselves have entered into guaranteed price and supply contracts with their suppliers.

These prices are based on oil futures contracts bought and sold, mostly electronically, on commodity exchange markets.

"For example," the oil retailer advocates explained, "when a consumer purchased a fixed-price contract last June for $4.89, that was likely as a result of the retailer having locked in supply at around $4. That retailer is not given a break by his or her wholesaler on that $4 now - the retailer locked in."

They concluded that while government has bailed out all manner of investment firms, mortgage companies and banks, "it hasn't bailed local oil retailers out of their expensive supply agreements."

"We are stuck with what Wall Street gave us - and we have no way to get out of them. If government gets us out of our supply agreements - we could help consumers."

Some oil dealers interviewed said the last few years have been among the most challenging for them in the business given the extreme market volatility.

"Some dealers are very sophisticated and then there are unfortunately other companies that buried their heads in the sands," Skarparas said.

"Oil dealers have to make an incredible amount of decisions," said Chris Brown, founder of newenglandoil.com, a heavily trafficked site that allows users to compare oil prices across New England. "A tanker of oil can get sold 300 times. It gets traded, constantly traded."

Brown, a computer software engineer who monitors the retail oil industry from Portland, Maine, said oil dealers aren't to blame for the price of oil. But like others interviewed, he said they do need to carefully educate consumers about the kinds of contracts they offer - and their downsides.

"They are responsible for the contracts they hand their consumers, and the consumers have some responsibility," Brown said. "If you're paying $5 a gallon, I'd take a contract to my attorney for 15 minutes."

Timing oil markets

From his office in Springfield, Ben Surner watches the price of oil closely as he lines up a season of heating oil contracts for Amherst-based Surner Heating Co., a company he founded more than 40 years ago. Surner said he's always tried to time the market to lock in the most competitive prices.

Last year, Surner Heating waited a month longer than usual to offer its fixed-price contracts because Surner, who buys 2 to 3 million gallons of heating oil each year, observed some price "slippage," as he put it.

"At the time we came out with our contract, we were the lowest in the Valley," said Surner, who was referring to a fixed contract at $4.09 per gallon last August. "Guaranteed price contracts means futures trading. We attach our costs. We will figure out what it needs to support the organization."

Unlike most other oil retailers in the region, Surner owns a wholesale pipeline terminal in Springfield where it can store about 2.1 million gallons of oil piped from New Haven, Conn., a main distribution point for heating oil in the Northeast. Nevertheless, the company must still buy futures contracts at a fixed price from suppliers each heating season.

Even Surner, who's been in the business as long as anyone, notes that timing the markets is not a science. Shortly after consumers and scores of other oil retailers locked in with wholesalers last year, the price of oil crashed.

Surner's son, Scott Surner, who runs the day-to-day operations of the company, said timing is the difference.

"In one month's time, things changed," he said.

Surner said profits are no greater than any other year for the company's contracted oil. He said he doesn't see local oil dealers making significant profits this year "and I don't see it on our suppliers' level either."

The guess work can be daunting for consumers who, whether they realize it or not, are bound up in the complex world of commodity market trading when they lock in fixed heating oil contracts.

"The average person is trying to determine what the world market is going to do," Scott Surner said. "This year a lot of people are unhappy. We understand that. A lot of people understand that."

Oil dealers interviewed said most homeowners who lock into fixed-price contracts each year have fared well, having paid less than market rate for heating oil over the past several winters.

"They will still be ahead of the game if they have been on our contract programs since 2001," Ben Surner said, adding, "It doesn't make them feel any better."

Oil speculation

In 2000, Congress effectively deregulated the U.S. commodities markets when it passed the Commodities Futures Modernization Act, a law some argue led to excessive speculation that ran up oil prices and damaged the economy.

Among the critics is Michael W. Masters, a hedge fund manager who co-authored a report released to Congress this week that outlined damage the crude oil bubble caused for Americans and businesses.

In the last six months, the report found, total investment in crude oil futures fell from $317 billion to $87 billion at the end of the December, a driving force in oil's historic crash, according to the report, "The 2008 Commodities Bubble: Assessing the Damage to the United States and Its Citizens. (The report, released to the U.S. House Committee on Agriculture, is available at www.accidentalhuntbrothers.com). A draft of the Derivatives Markets Transparency and Accountability Act was before the committee this week.

Masters was among those who testified before that committee Wednesday, pleading for stronger regulations and transparency in commodities markets, including so-called over-the-counter trading, or "dark markets" that go unregulated. The report found that last year's oil bubble had a ripple effect across many sectors of the economy and cost the U.S. more than $110 billion and American households $846 on average.

Masters is far from alone in calling for change. The oil industry, including state and national retail trade associations, is lobbying for commodity market reforms. Others Wall Street interests have stepped up efforts to quash tighter controls in oil futures trading.

Role of speculation

The role speculation played in driving up oil prices has received no small amount of national media attention. Last month, "60 Minutes" filed a report that raised questions about whether excessive speculation was responsible for the unprecedented run up in oil prices, not the laws of supply and demand. Here's how the CBS news magazine's Steve Kroft summed up the situation:

"It's impossible to tell exactly who was buying and selling all those oil contracts because most of the trading is now conducted in secret, with no public scrutiny or government oversight. Over time, the big Wall Street banks were allowed to buy and sell as many oil contracts as they wanted for their clients, circumventing regulations intended to limit speculation. And in 2000, Congress effectively deregulated the futures market, granting exemptions for complicated derivative investments called oil swaps, as well as electronic trading on private exchanges."

The Massachusetts Oilheat Council is one trade organization among many calling on federal lawmakers and the Obama administration consider tightening the reins.

"We want it to be more transparent," said Michael Ferrante, the council's president. "There's more work to be done to close speculation loopholes."

Advocates of regulation say closing these loopholes would place speculative limits on traders and protect the commodity markets from the wild price fluctuations that occurred last year.

Oil prices have flattened out and dropped below $40 per barrel this week. Valley oil dealers say it would be hard to imagine a repeat of last year's panic. Ferrante said he expects many oil dealers to take a harder look at how they price out oil contracts in the next home-heating season. He noted some dealers may do away with fixed-price heating season budgets all together and continue offering programs that offer more price flexibility and protections.

"Consumers have learned a lot this year," he said.

Dan Crowley can be reached at dcrowley@gazettenet.com.