By Noble Drakoln

Heating oil is a refined byproduct of crude oil. After crude oil is broken down during the refinement process, it is separated into heating oil. Similar to diesel oil, heating oil's official name is No. 2 fuel oil.

The use of heating oil gained ground with the invention of the oil burner in the 1920s. Until then, homes were heated by coal. Coal was messy, expensive, and required ample storage space and extensive manual labor on the part of the user. Conversely, heating oil freed up basement space and reduced pollution in the home - no soot or ash to contend with on furniture, clothing, and worse, in lungs. What's more, when heating oil is burned, a room thermostat can easily regulate heat to a consistent temperature. (These options represent one of the most important political commodities. Read more in Fueling Futures In The Energy Market.)

While heating oil contracts are used to hedge against price fluctuation in jet fuel and diesel, they are essentially different products and adhere to their own quality standards.

A sample commodity futures contract for heating oil is shown in the following table.

Heating Oil Contract Specifications
Ticker Symbol Open Outcry: HO (NYMEX)
Electronic:EHO
Contract Size 42,000 US gallons (1,000 barrels)
Deliverable Grades Generally conforms to industry standards for fungible No. 2 heating oil.
Contract Months All months
Trading Hours NYMEX Open Outcry: Monday-Friday
eCBOT Electronic: Sunday-Friday 6
Last Trading Day Trading terminates at the close of business on the last business day of the month preceding the delivery month.
Last Delivery Day Deliveries may only be initiated the day after the fifth business day and must be completed before the last business day of the delivery.
Price Quote U.S. dollars and cents per gallon
Tick Size NYMEX: $0.0001 (0.01 cents) per gallon ($4.20 per contract).

Daily Price Limit
(Not applicable in electronic markets)
  1. 25 cents per gallon ($10,500 per contract) for all months.
  2. If any contract is traded, bid, or offered at the limit for five minutes, trading is halted for five minutes. When trading resumes, the limit is expanded by 25 cents per gallon in either direction.
  3. If another halt were triggered, the market would continue to be expanded by 25 cents per gallon in either direction after each successive five-minute trading halt.
  4. There will be no maximum price fluctuation limits during any one trading session.

Understanding Heating Oil Contracts
Like every commodity, heating oil has its own ticker symbol, contract value and margin requirements. To successfully trade a commodity, you must be aware of these key components and understand how to use them to calculate your potential profits and loss.

For instance, if you buy or sell a heating oil futures contract, you would see a ticker tape handle that looks like this:

HO8X @ 3.1510

This is just like saying "Heating Oil (HO) 2008 (8) November (X) at $3.1510/gallon (3.1510)". A trader buys or sells a heating oil contract according to this type of quotation.

Depending on the quoted price, the value of a commodities contract is based on the current price of the market multiplied by the actual value of the contract itself. In this instance, the heating oil contract equals the equivalent of 42,000 gallons multiplied by our hypothetical price of $3.1510, as in:

$3.1510 x 42,000 gallons = $132,342

Commodities are traded based on margin, and the margin changes based on market volatility and the current face value of the contract. To trade a heating oil contract on NYMEX requires a margin of $10,125, which is approximately 8% of the face value.

Calculating a Change in Price
Because commodity contracts are customized, every price movement has its own distinct value. In a heating oil contract, one thousandth of a one-cent move is equal to $4.20. When determining NYMEX's heating oil profit and loss figures, you calculate the difference between the contract price and the exit price, and multiply the result by $4.20. For example, if prices move from $3.1510 to $2.9070, you multiply the difference, which is $.2440, by $4.20 to yield a contract value change of $10,248.

- Buy Sell Total Value
Heating Oil Contract Price
(1 cent move = $50)
$3.1510 $2.9070 0.244 cents or $10,248


Heating Oil Exchanges
The futures contract for heating oil is traded at the New York Mercantile Exchange (NYMEX), the Intercontinental Exchange (ICE) and Multi Commodity Exchange (MCX) in India.

Facts About Production
Heating oil is an important alternative energy source for homes that lack access to natural gas. While the majority of homes in the U.S. have adequate access to the necessary infrastructure that distributes natural gas, a small concentration of homes in the New England and Central Atlantic regions do not. A push has been made to convert older homes from heating oil to natural gas. Unfortunately, the expense and the uncertainty of the natural gas market pricing has left 8.1 million single family homes dependent on heating oil as their sole primary source of heat during the coldest months of the year - December through March.

This limited window of necessity has caused heating oil to become one of the most seasonally affected traded commodities available. As a byproduct of oil, heating oil takes lower priority than gasoline needs; therefore, refinement levels can fluctuate every winter from year to year, solely dependent on the amount of crude oil that was used to fuel cars during the prior summer. (Hedge against rising energy prices and diversify your portfolio with these funds. Find out more in ETFs Provide Easy Access To Energy Commodities.)

Factors that Influence Heating Oil's Price
The price is influenced by the following factors:
  • The severity of any given winter can have a significant impact on the price of heating oil. Because the concentration of homes affected by heating oil supply/demand fluctuations are concentrated in the Northeast area of the U.S., any major storms there can have a disproportionate effect on the actual movement in heating oil prices. If the area experiences unusually warm weather because of climatic shifts due to global warming, then heating oil prices could drop, solely because of a perceived glut in inventory.
  • The refinery capacity in the U.S. is very restricted. No new refineries have been built in approximately the last 25 years, and in turn, refineries are delaying heating oil production in order to address the intense demand for gasoline. If refineries continue to run at capacity for extended stretches of time past the summer months to produce gasoline, the duration of time allotted to refining heating oil becomes truncated and consequently has a significant impact on its availability.
  • Currency fluctuations can have an important effect on heating oil prices if low supplies or excessive demands require that heating oil must be imported from the Organization of Petroleum Exporting Countries (OPEC) or various other trading partners.
  • About 47% of the refining capabilities in the U.S. are concentrated in the GulfCoast region. The devastation caused by Hurricane Katrina alerted the world to how vulnerable this region is and how easy a single storm could bring the oil industry to a grinding halt.
  • As the price of crude oil increases, so too does the price of heating oil. Consumers have welcomed multiple alternatives to heating oil into their homes. Wood furnaces, corn pellets and biodiesel from vegetable oil are all being sought after as alternative fuel sources.
Conclusion
The price of heating oil is dependent on three factors: weather; the distribution of natural gas; and refinery capacity. Traders who are overly dependent on technical analysis can end up missing some of the subtle signals that any of these three factors may bestow on heating oil price fluctuations.

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