Cold winter may not dent U.S. heating oil, diesel glut

NEW YORK (Reuters) - U.S. stockpiles of heating oil and diesel, the fuels known as distillates, have brimmed to a 26-year high after a series of big weekly builds and even a bone-chilling winter may not seriously dent supplies.

This will likely keep a cap on heating oil prices, now about 55 percent below last year's peak.

"We are going into the winter with an outrageous amount of oil and will probably come out of winter with a fair degree of oil," Stephen Schork, editor of The Schork Report in Villanova, Pennsylvania, told Reuters.

U.S. inventory of distillates rose 700,000 barrels to 171.8 million barrels in the October 2 week, about 30 percent above the five-year average and the highest since January 1983, according to the Energy Information Administration. Analysts had forecast Wednesday's new data would show a 300,000 barrel rise.

"Although the distillate stock increase ... was modest, it ran counter to seasonal trends and increased the huge supply surplus," said Jim Ritterbusch, President of Ritterbusch & Associates, arguing it was bearish for distillates prices.

Weather forecasters tend to agree the U.S. Northeast, the world's largest heating oil market, is in for a winter of severe storms and frequent blasts of arctic air.

But since heating oil use is mostly confined to the Northeast, a big reduction in the distillate overhang will also require a meaningful rise in transportation and industrial demand for diesel as the economy mends.

"We see that about a year away," Schork said.

"No matter how you look at the ... situation there is a glut in the U.S. and many other consuming nations around the world," said Dominick Chirichella, senior partner at Energy Management Institute, in Point Pleasant, New Jersey.

"It is going to take a very strong economic recovery and some seriously cold weather to impact what will likely be distillate stocks at or near maximum capacity before the start of the main part of the winter heating season."

ALL FUEL STOCKS UP

Distillate stockpiles, up 40 percent from year-ago levels, have climbed as demand over the past four weeks hovered at 3.40 million barrels per day, down a whopping 9.5 percent from a year ago, EIA said.

U.S. stocks of heating oil rose 400,000 barrels at 51.6 million, up 33 percent from a year ago, with the overhang in the East Coast even more pronounced, 53.5 percent above last year. U.S. supply of natural gas, the key heating fuel in the Midwest, has hit a record 3.589 trillion cubic feet.

"This year, inventories are unusually high for all winter fuels," EIA said in a report last week. "As the economic downturn deepened throughout 2008 and 2009, energy demand fell, but supply was relatively slow to respond."

Heating oil futures, a proxy for wholesale prices, stood at $1.77 per gallon Wednesday, down sharply from a record high of over $4 last year. The average U.S. household will pay 8 percent less in heating costs this winter, EIA said in its winter fuels outlook on Tuesday.

Tim Evans, analyst at Citi Futures Perspective, said a repeat of the draw of 34.4 million barrels seen in the frigid winter of 2002-03 from current levels pulls inventory to 137.4 million barrels at the end of April, a little above where they normally are in the fourth-quarter in the past five years.

"We cannot get from this glut to a neutral or bullish stock level based on one colder-than-normal heating season," Evans told Reuters. "Inventories are so high that it will take more like 18 months to get them to normal levels."

MARKET ENCOURAGES STORAGE

One reason for rising distillate stocks is a steeper contango -- or higher price for further-out futures contracts relative to the front month -- in heating oil versus benchmark crude. That is encouraging domestic refiners to maximize fuel production despite lackluster profit margins, analysts said.

"It's better for refiners to refine crude oil into products, then store those products," for future sale, Schork said.

The distillate supply rise is negative for heatoil refining margins and bearish for fuel prices, said Paul Horsnell, head of commodities research at Barclays Capital in London.

The November heating oil crack, or profit margin from turning crude oil into the fuel, was $5.30 per barrel Wednesday, down from about $12 in the summer.

"While gasoline demand looks fine, distillate demand remains very weak," with an 11.6 percent year-on-year decline for September-to-date, Horsnell wrote in a report last week.

(Additional reporting by Gene Ramos and Rebekah Kebede; Editing by Jeffrey Jones and David Gregorio)