The Coming Winter Offers Cold Comfort for Oil Bulls

By LIAM DENNING Inside every oil bull beats the heart of a brooding pessimist. If they aren't proselytizing about "peak oil," they are kicking around Tom Clancy-esque war scenarios or dreaming of a (bitterly) white Christmas. So it hasn't been a good week for them. Russia said Friday that its oil output crossed 10 million barrels a day in September, 25% more than Saudi Arabia. Over the weekend, militants in Nigeria, producer of some of the world's most sought-after grades of crude, appeared to accept an amnesty. Still, there always is hope that winter will stoke demand for heating fuel. Don't bet on it. U.S. energy officials released on Tuesday their winter fuel outlook. Demand for heating oil in the Northeast, which accounts for 80% of consumption, is projected to drop 2% year on year on a relatively mild winter. There already is too much distillate, a category of refined products that includes diesel and heating oil. Inventories, at 171 million barrels, stand at a 27-year high, according to JBC Energy, a research and consulting firm. Michael Morris, an economist at the Energy Information Administration, reckons a 10% colder-than-average winter boosts U.S. heating-oil demand by between 90,000 and 125,000 barrels a day. Factor that in from October through March and it totals up to an "extra" 23 million barrels of demand. If the buffer of distillate inventories still doesn't seem big enough, consider that low natural-gas prices will mean those who can switch away from heating oil will do so. The pressure put on incomes by rising unemployment, another piece of bad news from the past week, also should spur conservation efforts. Across the Atlantic, European distillate inventories also are high. JBC estimates a cold winter there might generate incremental demand for heating oil of 48 million barrels, but there is more than enough onshore inventories to offset this if it materializes. When there is too much inventory, profits drop and producers, refiners in this case, slow output and dump product. Valero Energy, the largest refiner in the U.S. by market capitalization, shut down a unit at its Delaware City, Del., refinery over the weekend due to low margins. As refiners are oil producers' main customer, weak demand for refined products feeds up eventually to weak demand for crude, where there is spare capacity already. Inventories of gasoline and crude oil also are above five-year averages. And that doesn't capture fuel stored at sea: JBC estimates there are between 71 million and 92 million barrels of crude and refined products sitting in tankers in the Atlantic Basin. Barring a rapid recovery in demand in the industrialized world, 53% of consumption against China's 10%, there is little prospect of clearing that quickly. As energy economist Phil Verleger puts it: "Anyone got a match (or a torpedo)?" Write to Liam Denning at liam.denning@wsj.com