3 propane price-protection strategies

August 26, 2014 By and    

Weigh your options to shield customers from runaway propane prices

A confluence of events last winter put pressure on propane supply points and wholesale propane prices. Some propane retailers who thought they were prepared entering winter were caught scrambling to find propane at any price.

The high prices were passed along to end users, as they should be for those customers buying at market price. Even propane users in warmer climates had to deal with higher prices because cold-climate retailers reached out hundreds of miles to find product.

Consumers who were enrolled in price-protection plans were generally spared the high price issues. But some had to accept short deliveries to get through the worst weeks of the winter.

In extreme cases, retailers declared a force majeure – if they had included such a clause in their price-protection agreements. Force majeure clauses are generally meant to protect retailers from liability and obligation when extraordinary events or circumstances beyond their control occur.

It is doubtful force majeure would stand up in court simply because certain U.S. regions were having a cold, snowy winter – and especially if retailers did not take steps to prevent or limit the effects of the weather interference and related demands on supply.

Force majeure clauses are now quite standard in the price-protection agreements retailers offer. They serve a purpose in some extreme situations. But no matter why the clause is enforced, it will have devastating effects on propane retailers’ businesses. Cold propane customers find other suppliers or other forms of energy to keep warm.

I was enrolled in a price-protection plan with my propane provider last winter. The company delivered my propane on time and at my contracted price, and it did not make any short deliveries. Still, even satisfied propane consumers seem to know a friend or relative who had a bad propane experience last winter.

Overall, the propane industry did a heroic job to keep customers warm last winter, with much of the credit going to retailers who prepared for a normal winter yet planned for worst-case scenarios. Many retailers learned that disciplined approach from the price-protection programs they developed and refined over the years.

If you are operating in a market where price protection is a viable option, your customers and other propane consumers are likely contacting you to see what you have to offer. Here are just a few of the variations for retailers.

Cash pre-buy – Customers buy a fixed amount of gallons for a fixed price, for winter use, based on use history and how much of the estimated use is covered. It is basically a cash transaction well in advance of need and is popular with some consumers, especially farmers. Hedging investment costs to retailers are generally rolled into the per-gallon price.

Lock-in price – Customers agree to a locked-in price for the winter and pay for propane as it is delivered. There is generally a lock-in fee charged to cover the propane retailer’s hedging expenses. Sometimes, the fee is a per-gallon charge rather than a lump sum so retailers can capture an added hedging expense on larger users.

Price cap – Customers agree to a cap on their propane price for the winter, with their price following the market up and down but never exceeding the agreed-upon price cap. Usually, there is a fee charged to customers for a price cap, but last winter’s price volatility created some demand for a relatively high-priced cap with no added fee. The retailer’s hedging expenses are rolled into a cap price that is substantially higher than the typical lock-in price. The cap price still offers protection from runaway market prices like the ones seen last winter, though.

The real discipline for retailers comes with hedging the cost of every gallon sold under price-protection plans, before or as those protected gallons are sold. Hedging is making an investment to reduce the risk of adverse price movements.

Offering price protection without completely hedging your offerings is like opening a poorly run propane casino for your customers. You both have a high risk of becoming big losers, and the propane industry’s image will be a loser, too.

Tom Jaenicke is the founder and the principal adviser at ATomiK Creative Solutions LLC. He can be reached at tom@atomikenergysolutions.com or 810-252-7855.

 

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