Home Economy: Locked in

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“Oil Prices Expected to Soar,” screamed a New York Times headline last August. The Times was not alone. Energy billionaire T. Boone Pickens made similar comments as did many others, most who convincingly argued that a growing world economy had an insatiable thirst for all forms of fossil-based fuels. And while demand seemed almost unlimited, supplies were tight.

Similar evidence could be seen at service stations as the price for a gallon of gasoline also crossed the $4 threshold. Soon after most of the doomsayers had their say, this trend quietly began to reverse.

But before a crude oil price drop could be felt by consumers, many users of home heating oil bought into fixed-price contracts and by doing so ventured into very risky financial territory. Banking on the basic free-market principle of supply and demand, these consumers gambled that, in the long run, they made the right decision. Prices would continue to rise, but they’d get the lower price by ordering in advance. And if crude prices had continued upward, a trend that looked destined to happen last summer, they would have been right.

However, buying futures of any sort is risky for a reason, namely that there are too many variables at play. This makes accurately determining future price movements—from soybeans to cattle to oil—nearly impossible. In the case of those who bought fixed-rate heating oil contracts last summer, they probably did not see two other occurrences that were taking place that would severely influence the price of oil. One was that the high prices for anything with a petroleum base was causing nearly everyone from farms to factories to private citizens to find ways to conserve fuel. That initiated a slight drop in demand, mostly in the developed countries. What soon followed on a broader scale was a global economic slowdown or recession. On a macro-economic level, the conservation effect of the American consumer was multiplied to a worldwide level as global users of everything from diesel fuel to kerosene were buying less as demand for nearly every type of consumable dropped, reducing factory output as well as petroleum-product usage.

Flipping back to the consumer who “locked-in” a home heating oil price in the $4-per-gallon neighborhood, the landscape was starting to drastically change. Lower fuel prices are obviously good for the consumer but not good for anyone who locked-in when prices were at their peak.

“Fixed-price contracts are pure speculation,” said one eastern Long Island-based heating oil company executive who spoke only under the condition of anonymity. Calls to numerous South Fork heating oil companies requesting comment on fixed-price contracts were not returned. “We advised our customers against this because it generally does not work in the customer’s favor,” the executive continued. “But last August many of them demanded it.” Last August home heating oil was flirting with a price of $4.50 per gallon, nearly 40 percent higher than a year earlier, making it easy to understand the slight case of panic that was beginning to grip heating-oil customers. Today, thanks to shrinking demand and rising inventory, the price has fallen to about half that. “About 25 percent of our customers took fixed-price contracts,” noted the official. “That is an unusually high amount.”

Bill Berkoski Jr., vice president of Berkoski Oil Company in Southampton, says his company does not offer fixed-price contracts to its customers.

“It’s a double-edge sword,” he says. “If prices rise, you’re happy, but if they fall, you’re locked in, angry and legally bound to buy at the agreed-upon price. Why make a deal on something over which no one has any control?”

And nearly everything can affect the price of oil, from natural disasters to political instability to economic manipulation. These wild cards make it virtually impossible for anyone to reliably offer any sort of long-term, oil-price forecast.

Most fixed-price contracts feature a “penalty clause” that allows customers to “buy” their way out of the agreement, usually for $500 to $600 for an order that was valued at about $4,500 at time of purchase. The customers are then free to purchase their heating oil on the “spot market” from any dealer. Customers can also purchase insurance to protect themselves against oil price drops, but this practice is very rare.

Recently, William Lindsay, presiding officer of the Suffolk County Legislature, has introduced legislation to protect consumers from what Mr. Lindsay describes as “unfair heating oil contracts.” The lawmaker wants any oil purchasing agreements not put in writing to be invalidated. Verbal contracts between customers and their oil suppliers would be null and void, if the bill is passed.

“In these terrible economic times, families are having difficulty making ends meet and residents should never have to choose between keeping their homes warm and putting food on the table,” Mr. Lindsay said. “Getting locked into a contract they don’t understand over the phone is just wrong, and I want that practice to end. Consumers need to understand what they are getting into and requiring written contracts is the best way to do that.”

However, even when a customer pays the termination fee and gets out of the contract, on the other end of the equation, the home heating oil supplier still owns the oil, which it bought on the customer’s behalf, at the higher wholesale price. In this case, the heating oil company will suffer a loss on these purchases, despite the penalty payment.

Regional operating costs and shipping, wages/salaries, benefits, equipment, lease/rent, insurance, overhead, and state and local fee plus distribution and marketing account for about 46 percent of the cost of a gallon of home heating oil. The next largest component, crude oil, accounts for approximately 42 percent of the cost of a gallon of heating oil. Lastly, refinery-processing costs account for another 12 percent, according to the Energy Information Administration, the official supplier of energy statistics to the federal government (www.eia.doe.gov). When this is combined with an inability for some smaller oil delivery firms to get credit, which they traditionally rely upon to bridge the gap between order placement and receipt of customer payment, well, it’s been a tough time to be in the home heating oil business. As a result, some of the smaller companies, which cannot sustain such losses, have gone or will go out of business.

While no one knows what the future of energy prices will be, Mr. Berkoski remains against fixed-price contracts and urges each of us to do what we can to reduce consumption.

“In this economy, the oil market has no central price,” he says. “But consumers are making a difference. Equipment upgrades, moving to alternative energy and conservation has made a dent in usage.”

Joseph Finora Jr. is a freelance writer in Laurel. Contact him at jfinora@optonline.net.

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