Marketers must recognize, react to a decade of dwindling gallon sales

Editor’s note: This is the second in a three-part series analyzing the decline in propane sales over the last decade.

The raw numbers tell a grim tale: Propane sales in the United States fell 2.5 billion gallons in the first decade of the new millennium to finish at 9.6 billion in 2009. And the preliminary 2010 numbers forecast another 300 million-gallon drop.

That 23 percent falloff shows up in all market segments (residential, commercial, engine, farm and industrial) and in propane retail companies of all sizes and locations. Perhaps most concerning is that it happened in the midst of the industry’s unprecedented $250 million investment in research, development and marketing work of the Propane Education & Research Council (PERC).

The bleak performance data from the American Petroleum Institute has industry leaders scrambling to find a strategy to counter propane’s shrinking slice of America’s energy pie. But with crude oil prices expected to surge to $125 a barrel this year and a near-bankrupt government unable to craft a national energy policy addressing alternative fuels, the discussion struggles to find traction.

Conversations with industry executives indicate the 99-year-old propane industry is facing profound changes that threaten the long-term viability of the market. Most agree that solving those challenges will inevitably change the way marketers run their business.

What does it mean?
Some propane marketers argue that the number of gallons sold is not as important as the margins they generate. Still, the drop in sales since 2000 is a critical trend for the propane industry to recognize and address, according to Michael Sloan, senior project manager for the consulting firm ICF International.

“It’s really a critical issue for the industry to be aware of what we are talking about. If [marketers] don’t recognize or understand it, they won’t do what needs to be done. We don’t have the answers yet, but talking about it is an important first step,” Sloan says.

Researchers at ICF and its predecessor company have been studying the trend’s detail for PERC since 2003. Their analysis of the fast-changing energy landscape and emerging market opportunities has been a key in guiding the council’s strategic investment decisions.

“Energy markets in general – and LPG specifically – are changing. That change is driven by many factors, some of which the industry has some control over and others that it is not able to influence,” Sloan says.

“It’s nothing new. All the way back 100 years you can see similar changes in the market. But those industries that don’t adapt have died. So it’s adapt or die,” he warns.

Sloan says he thinks the propane industry has done a reasonable job adapting to change the last 10-20 years. But record crude price spikes, a nasty three-year recession, the collapse of the housing market and consumer conservation all had drastic impacts on sales beyond its control.

Those factors and others began steadily pushing up the price of propane in 2004. The result was a crucial swing of customers away from propane to competing fuels within the bread-and-butter residential market. Coupled with improved energy efficiency in furnaces, space- and water-heating equipment and building codes, ICF estimates that the propane industry surrendered about 800 million gallons in sales in its most robust market segment.

“If propane prices had stayed at the levels they were early in the decade, it would be a very different market right now to our favor,” Sloan observes.

“You also see a growth in electricity space heating that accelerates during the same periods. That tells me that the propane price spike was one of the things that drives that. Clearly, when you see a big change in 2008-09 associated with the run-up in propane prices you can say the two are linked, as opposed to just a correlation. One was driving the other.”

Priced to compete
Propane continues to lose its historical pricing advantage vs. electricity. Since 2000, residential propane price increases have outpaced electricity, increasing on average by 91 percent between 2000 and 2010. By comparison, electricity prices rose just 41 percent during the same period.

“Every year the Department of Energy publishes the cost of our fuel per Btu vs. the other fuels. The latest says we are at 90 percent the cost of electricity. I can remember when we were at 60 percent,” observes Gene Bissell, president and CEO of AmeriGas Propane.

That cannot continue if propane hopes to compete for dwindling gallon sales. ICF and others in the industry believe propane prices will fall as oil markets stabilize and NGLs are pulled from the shale gas fields.

“What happens with oil prices, shale gas and the associated liquid production will have a very large impact on the price of propane. Price is one of the key drivers behind the loss in gallons and the loss of customers in certain markets. And it will play a key role in what happens to our industry going forward,” Sloan says.

Can the trend be reversed? Except pricing, the factors driving the market are unlikely to change, he warns.

“Improvements in energy efficiency will continue indefinitely; that’s pretty much set in stone. As old furnaces are replaced with new, efficiency improvement will be significant enough in most cases to substantially reduce heating loads for that household. That number can be as high as 40 percent reduction in fuel consumption.

“Plus, new houses are inherently more efficient due to building code changes. Those trends are just not going away,” he says.

Feeling the pinch
The nationwide sales losses have the full attention of the propane industry’s multi-state, publicly owned companies.

“It’s something that we’ve been concerned about for a number of years as we looked at the data. As the largest player in the market, we have the biggest stake in growing the industry,” says Bissell.

“We all need to be very focused on it. It’s something that has been out there a while and I couldn’t quite understand why nobody was talking about it.”

AmeriGas has experienced a drop in customer consumption rates consistent to the national average reported by ICF, Bissell says. Since peaking at almost 1.1 billion gallons in 2001, AmeriGas retail sales have slid to 928 million in 2009.

“To me it’s another alarm that we need to support NPGA, PERC and Propane PAC. We certainly don’t want to be an industry where we are shrinking and so instead of working together the strategy is to steal others’ customers. That won’t lead to the kind of growth we are all looking to.”

Bissell, a past NPGA chairman, supports the association’s push to have propane added to the T. Boone Pickens-backed “NatGas” bill promoting natural gas development. The bill was introduced in Congress in April with no mention of propane.

He also views NPGA’s fight to entrench PERC programs as vital. In late 2009 PERC was forced to shut down some $10 million a year in wide-ranging consumer education programs that promoted the benefits of propane.

“We need to work together to get legislation to permit PERC to help us grow through customer communication. I think everyone felt pretty good about that program before it was shut down. We have to find a way to get that fixed,” Bissell says.

The nation’s second largest propane retailer likewise has seen a falloff in retail sales from 947 million gallons in 2000 to 839 million in 2009.

“I think it’s a
wake-up call for the industry,” says Ferrellgas Partners CEO Stephen Wambold. “The report confirms what a lot of people have been thinking. Our industry tends to think that weather is the only thing that drives [sales] numbers year to year. But it’s pretty clear that there are other forces that come in to play.”

Wambold concedes the proliferation of electricity growth across the nation has been “stunning.” The propane industry needs to do a better job educating consumers of the differences in cost and environmental impact based on source-to-site data already recognized by the government, he says.

The last decade saw most multistate marketers experiment with various forms of operating system upgrades and structural consolidations. While efficiencies were realized, there also were problems that likely cost the industry customers, Wambold admits.

“There was a lot of trial by error. Some decisions paid off and some didn’t. At the end of the day, it all depends on your standpoint. Was it successful? From a shareholder perspective, yes. From a gallons perspective, no. It all depends on what side of the fence you’re on,” he says.

Growing gallons in a shrinking market will require the industry to collectively push new and emerging applications it has been slow to embrace.

“I hope this gets people on the same page regarding diversification of our product,” Wambold says.

“We need more money invested in R&D – specifically in motor fuel. Engine fuel sales are up 144 percent for us. They are small numbers, but they are coming on quickly. I think the industry as a whole is probably still on the fence [regarding autogas], but we have got to diversify and get this going with some momentum.”

Ferrellgas has partnered with Roush CleanTech to launch a national program to encourage fleet owners to try propane. The project allows any government agency, company or utility with more than 10 vehicles in its fleet to request use of a propane van for a week or two.

Carl Hughes, senior vice president of business development for Inergy LP and incoming chairman of the National Propane Gas Association, doesn’t think the consumption patterns reflect poorly on the propane industry. Natural gas, he notes, has experienced the same reduction rate over the last decade.

“We talk about it as if our product is horrible, and so we bunker in. It’s neither bad nor good; it just is. It’s natural with the more efficient furnaces and appliances,” Hughes observes.

“So many things are going on with consumers that make it a very complex market. But consumption trends don’t lie to you. We tend to look at our own processes and say, ‘We are getting killed. How can we return to where we were?’ I don’t think we will. I think it’s a mistake to even think about it. Conservation will continue.”

Inergy, which went public in 2001, is the fourth largest domestic propane retailer with 376 million gallons in sales in 2009. But its totals are down too, from its peak 419 million gallons sold in 2005.

Hughes thinks it’s imperative that the industry be as objective and honest about itself moving forward in a dynamic business climate.

“I know that as a product we have survived 100 years in the residential market. It’s hard to find another product that has done that. There’s no question that our product for home heating, water heating and cooking is a wonderful product. It’s not going away,” he says.

He believes the price disparity between natural gas and crude is bound to improve and, eventually, help the cause. But he also knows that propane can be left behind as lawmakers grope for a plausible energy strategy.

“We have to make sure that we create a climate in Washington that gives us a leg up or a level playing field. That’s what we’re fighting for; it’s that simple. If Congress wants a policy that supports one energy over another, we have to be part of that. If they want competition, I think we can do very well in that arena. We just want a level playing field – favorable conditions in which to compete.”

Independents react
Through the mid-1980s, motor fuel sales comprised about 20 percent of the gallons sold by the nation’s largest independent propane retailer, Mississippi-based Blossman Gas. Since then, the share has dwindled to less than 1 percent.

Meanwhile, annual sales for the 11th largest U.S. marketer are down from 72 million gallons in 2000 to 64.5 million in 2009. Company Chairman and CEO Stuart Weidie says the dour trend steered his company back to the motor fuel market for new gallons.

It took almost four years to study and develop, but Blossman two years ago launched a partnership of propane retailers, equipment providers and certified conversion centers to convert fleets from gasoline to clean-burning propane. The nationwide Alliance AutoGas network also offers on-site fueling, ongoing safety training and technical support.

“The reason we did that was that we saw 10 of 12 warm winters, which have been the Holy Grail for our industry forever,” Weidie explains.

“Autogas is an opportunity to eliminate some seasonality and utilize domestic supply that is available to us now and will be more so in the future with shale [natural gas supplies]. There is no other fuel as user friendly and cost effective as propane,” he says.

The addition of new vehicle offerings, the extension of tax credits on propane, storage and dispensing equipment and the spiraling cost of petroleum have aided the program’s acceptance, according to Weidie.

“One reason we formed Alliance was to promote and grow the pie. If we get the pie big enough, we all get substantial gains in gallons sold,” says Weidie, who acknowledges that more than half of the propane industry marketers remain skeptical and uninterested in that market segment.

Weidie also feels strongly that marketers need to get back to selling the gas-burning products that helped create a market for the fuel.

“First and foremost, as an industry we are not promoting products – and that has been a large factor in the steady decline of retail sales. Everyone wants to sell and deliver gas, but there are fewer and fewer of us that sell, install and service the products that use the gas. In some respects we have ceded the sale of products to the ‘big box’ stores or companies that may not have interest in promoting propane,” he says.

Weidie says the industry can compete selling higher-end gas logs, space heaters, generators and other merchandise with smaller markups. But marketers need to accept the associated costs on that side of business in order to secure the gas loads otherwise lost to electricity.

“Everyone needs to gain new business organically through the sale and installation of these products. We need to create markets – not just sell gas. Unless we as an industry get more innovative in finding and promoting products, the likelihood of growth for our industry is diminished. It’s not hopeless, but it’s going to take a renewed commitment to sell products in addition to gas.”

In rural Sherman, Texas, just outside Dallas, Douglass Distributing has been selling propane for 30 years. Forty-five percent of the company’s 4 million gallons serve the residential market; the rest are industrial (forklift and motor fuel).

President Brad Douglass says the signs of change are clear and the threats real for a mature industry heading into early decline.

“The declining industry volume will create battles for market share. Our industry seems to use price as the principal point of differentiation, so the marketer’s future could be smaller volumes and smaller margins. This toxic combination will bankrupt the undercapitalized and o
verleveraged companies of all sizes,” Douglass says.

The higher prices of propane compared to electricity have accelerated the decline, he says, forcing consolidation of the remaining marketers into larger and more efficient businesses. Surviving companies likely will need to recruit higher caliber staff to run them, and decision making will be strictly on financial data rather than an owner’s gut feel.

“Many propane business owners have lost the fire in their belly with the Great Recession,” he observes. “They have only raised prices in an effort to go broke slower.”

Douglass agrees that marketers must diversify their income streams in lieu of organic growth. Instead of relying on fuel sales as the primary source of earnings, they should add service and equipment sales to offset the lower gross profits from propane.

And they need to push those sales by educating key decision makers such as homebuilders.

That strategy has helped sustain Revere Gas & Appliance, a 65-year-old, third-generation family marketer in Virginia.

Company Vice President Carlton Revere says the lack of home construction and the price of electricity in his region have hurt gallon sales the last few years. But there’s steady business in sales of tankless water heaters, outdoor hearth products and now commercial lawn care products that create fuel load.

“We promote the heck out of energy credits for high efficiency equipment,” Revere says. “We’re still seeing a lot of home remodeling, so our showroom sales have remained stable. We sell the higher quality products that are typically higher in cost. The unit sales may be a bit down, but prices are up. It’s not just all about aesthetics anymore, and customers are willing to pay for that quality.”

Revere also notes that most marketers have realized the cost-saving benefits of delivery management, routing and inventory control technology to ease the sting of gallon erosion.

The boom in fuel oil conversions is helping Tim Johnson add lots of new customers for Propane Plus Corp. in Massachusetts. Yet his annual sales of 2 million gallons to residential and commercial customers haven’t budged.

“I’ve been struggling to get our gallons up even though we target 150 new customers a year,” the company owner reports. “Our gallons have been flat for the last five years. But we are more profitable.”

The high price of fuel and a struggling economy have New England customers conserving wherever possible. Plus, the new tankless water heaters and high-efficiency furnaces are whacking big chunks of household consumption, Johnson says.

“All these factors are definitely playing into it. Consumers are more aware of the cost to run everything. And on top of that, they are conserving.”

But 20 years in the business has taught Johnson that it’s not all about the gallons.

“If I can sell 2 million gallons and make a good profit, I’m OK with that,” he admits. “Margins in general have grown, which is good for the industry. Even in a down economy, we are making money this year.”