As heating oil dealers go about lifting product at the rack (oil terminals) every day, there are subtle, and not so subtle nuances to the variables that impact that cost. Everyone is familiar with the obvious mover of price, the futures market. It moves with rapidity and, most would agree, unpredictably.
The other price mover that is at times subtle, and at other times not so subtle, is basis. Most of us in the industry view basis simply as the delta between the Nymex spot price and what we pay at whatever terminal we happen to be lifting product from. Basis is the best indicator of localized supply & demand for a particular market or region. As a consultant I have frequent discussions around strategies to control basis in order to hedge efficiently in addition to profiting from location anomalies that might pop up on the radar. We are always drilling the importance of managing basis into our clients’ heads. Lots of monies are left on the table if mismanaged!
There are a host of factors that can move the basis lower or significantly higher. In this article I’m going to focus on one of the variables that I am intimately familiar with due to my background in the shipping industry.
One of the most dominant, yet mysterious components that influence oil prices is the cost of moving the product around. “Shipping” the oil is effected via water, pipeline, rail or truck. Let’s look at the “water” method and understand how it impacts basis. A large majority of heating oil, ultra-low sulfur diesel, and gasoline volume is delivered by barge on the east coast. These vessels, with capacity ranging from as little as 15,000 barrels to upwards of 150,000 barrels, offer greater flexibility than pipeline delivery without fixed contracts. Unlike trucking or rail, they can move large volumes in a single “voyage” quickly and economically. Barges loading in New York Harbor with heating oil and ultra-low sulfur diesel are likely the source of supply to a terminal near you. The most common delivery and supply destinations for oil ships loading in New York Harbor range from as far north as Portland, ME to as far south as Baltimore, MD.
Weather, seasonality, refinery outages, and fuel prices all play a significant role in determining rates. Demurrage, the charge the supplier pays to the barging company in addition to the charter rate for using the barge beyond a specified time frame, is another inflationary factor. Inclement weather can also affect charter markets by delaying tonnage and making availability scarce.
What about fuel prices? With the cost of distillates rising over they years, the fuel that runs the ships does have a significant impact on rates and ultimately the cost of product. It is common knowledge that with barge owners currently operating on historically thin margins, the charter rates for these small ships have closely corresponded with fuel costs. In fact, according to the barge broker I worked for, Poten & Partners, charter rates on all sizes of equipment correlated closely with the price of fuel over the last year. For example, charter rates on the 20-30,000 barrel size barge started the spring of 2012 near $1.00 per barrel on movements across New York Harbor. By July, with fuel prices trending lower, the same barge was chartering closer to $0.75 per barrel on the same movement across New York Harbor. Today, that rate is back up to around $0.90 per barrel.
Seasonal factors can affect charter rates as well. Finding a barge to move ultra-low sulfur diesel or heating oil during the spring months while most of the fleet is being cleaned to operate in the gasoline trade can be difficult. Barge owners understand that they have the leverage of holding scarce equipment to move a specific cargo during these transitional times of year and therefore can push the charter rate for their equipment dramatically higher.
Yet another very influential component embedded in shipping costs is rooted in The Jones Act. Also known as the Merchant Marine Act of 1920, this federal statute regulates maritime commerce in U.S. waters and between U.S. seaports. It mandates that all goods transported by water between U.S. ports be carried on U.S.-flagged ships, constructed in the United States, owned by U.S. citizens, and crewed by U.S. citizens. Its purpose is simple; to protect and support the U.S. maritime industry. Well intended, the decree can effectuate higher shipping costs. U.S. minimum wage laws, a lack of U.S. shipyards, and a shortage of American-produced steel are several factors spawned from this early century statute. As domestic taxes and prices for materials and personnel rise, there is less incentive for ship-owners to produce more vessels to service the trade. Fewer vessels servicing the trade means a tighter market and higher charter rates for suppliers. With the strict, expensive requirements of the Jones Act already contributing to dwindling fleet size, even modest weather systems in the Northeast can quickly cause a scarcity of available tonnage for suppliers to move their cargo. The delays that result from inclement weather can translate into large demurrage claims suppliers are liable for while tonnage is ‘on the clock’ waiting to discharge cargo. Consequently, certain iconic events like Hurricane Sandy have prompted the President to wave the Jones Act. The waiver allows suppliers to use foreign-flagged vessels to avoid Jones Act restrictions so that product can be supplied with minimum price or supply disruptions. In addition to storms, severe cold can also have an impact on shipping costs. Ice formation can prevent barges from reaching their discharge destination or seriously delay them in their voyage. Ice charges, like demurrage charges, are built into the charter contracts to suppliers by barge owners. The provision allows for the billing of costs associated with additional time used by a barge to complete its voyage due to the ice delays.
A precise formula for understanding every aspect of the price will never exist because each situation is unique and subject to a variety of elements. What is certainly evident is that the cost associated with transportation will always be passed on to end-users by suppliers because they don’t have the margins to absorb the extra costs. With barge markets accounting for a large majority of transportation in the heating oil and ultra-low sulfur diesel markets on the east coast, you can be sure that as charter rates move, so will basis, and ultimately your cost at the rack.
The information provided in this article is general market commentary provided solely for educational and informational purposes. The information was obtained from sources believed to be reliable, but we do not guarantee its accuracy. No statement within this article should be construed as a recommendation, solicitation or offer to buy or sell any futures or options on futures or to otherwise provide investment advice. Any use of the information provided in this article is at your own risk.