Ask the expert: Heating oil prices and contracts

5:58 PM, Jan 14, 2013   |    comments
JAMIE PY
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Why do dealers offer Heating Oil Programs? A few years ago the idea of offering the consumer "Peace of Mind" regarding their cost of heating oil for the upcoming winter season was born.

How can a dealer offer a fixed price? When a dealer offers a fixed price he has gone to his supplier and agreed to purchase a certain amount of gallons at a fixed price. He signs a contract with his supplier and picks up the fuel at the fixed price agreed upon when the product is needed for his consumer.

Does a dealer have to buy contracts when he offers a fixed price? At first the answer was no. Some dealers would take a chance that they might make money if the price were to go down although the best management plan would be to buy simultaneously. In 2006 that changed. A dealer entered into several fixed contracts with the general consumer and with some municipalities and then did not deliver the product. These "innocent" consumers were left with no oil and less money in their budgets as they had prepaid the dealer for the oil. This scenario came shortly after a dealer in NH had done the same thing.

What happened to rectify this situation? A law was passed in 2006 requiring dealers to purchase contracts from their suppliers to cover at least 75% of the prepaid gallons they had sold. This law was passed to protect the consumer.

Why only 75%? There is always some fluctuation to the actual gallons used by the consumer due to weather, etc.

So what happens when the dealer purchases these contracts and the price of oil goes down? The dealer has signed a contract which is legal and binding with his supplier. He is obligated to purchase the fuel regardless of current market conditions. If he does not pick up the product when he is supposed to, he is billed for the product at the fixed price and he is also charged a penalty by his supplier. As you can see, they have no choice but to buy the product at the agreed upon price as they will have to pay for it no matter what.

So what happens to the consumer who has purchased a fixed contract when the price goes down? The consumer has also signed a contract to purchase oil from his dealer at a set price. The dealer has fulfilled his legal obligations by purchasing the gallons required by law to cover the gallons sold to their customers , therefore the consumer has a legal obligation to purchase the gallons they had contracted to buy.

So how does buying a Heating Oil Program from a dealer protect the consumer? Over the past decade the consumer has benefited greatly by locking in their heating oil price as the trend is for these programs to be offered in the spring (when demand is low) so that prices tend to be lower than the winter prices when demand is higher.

Program prices this spring were very high and now the price of oil has dropped drastically. What can the consumer do at this point in time? Unfortunately the deals are done. They have agreed to buy the oil from their dealer at a fixed price and the dealer has agreed to buy the oil for them from their supplier at a fixed price. A contract is a contract on both ends. The best thing a consumer can do at this point in time is try to conserve.

 

What can a consumer do in the future to protect themselves against this huge price swing? There are packages that are available offering downside protection (these are not fixed prices, they go down with the market and usually have a capped price on how much the consumer pays).

But this type of "downside protection" costs the consumer a lot of money. Why would they want to buy it? First, this type of protection costs the dealer a lot of money as well. If a consumer wants the best of both worlds the buying downside protection is for them. It is an 'insurance package" that covers them in an "up and down" market. Buying a Heating Oil Program should be looked at like purchasing Health Insurance. The gambler might save money up front by not buying "catastrophic health insurance" on the chance that they might not need to use it where the more conservative person is willing to pay a little more up front for that extra coverage. Regardless of which insurance they buy they have made a deal that is legally binding when it comes to their medical bills. Buying a heating oil package is no different. The consumer needs to decide if they are willing to gamble or if they want to play it safe.

What causes these huge fluctuations in oil prices? Oil is a commodity that is traded on the commodities market. Unfortunately, unlike a decade ago, trading oil has little to do with actual "supply and demand" so it is difficult to predict where retail prices will be. As most have seen a huge drop in their stock portfolio's (401k's, investments, etc) they have also seen this huge drop in oil price. Until regulators rein in speculation in the energy markets the consumers and oil dealers alike are subject to volatility in the market. It is up to the consumer to decide what type of "Insurance" they want on their oil prices.

For more information on speculation in commodities markets see this web site http://accidentalhuntbrothers.com  

This story was originally posted on November 26, 2008.

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