Winter worries

September 1, 2004 By    

Unseasonal weather and growing residential demand will again be key factors in the upcoming winter supply season, but record crude oil prices this summer also should be factored into this year’s equation.

Weather, as Always

The National Weather Service’s Climate Prediction Center predicts a warmer-than-normal weather again this year. Unseasonal warmth during the prime winter heating-degree day season is particularly likely in the Midwest, where propane home heating is most popular – more than 9 percent of households, according to the 2000 U.S. census.

 Propane Stocks (Million Barrels)
Propane Stocks (Million Barrels)

As the winter season progresses, the Weather Service projects the above normal temperatures will expand to the rest of the country. Major exceptions are Texas and a large inland portion of nine states mostly in the Northwest, which should have more seasonal weather.

A meteorologist for one major oil company, however, was forecasting colder-than-normal weather east of the Rockies for a three-month period starting in September. That could mean strong early demand for heating season fuels.

Which forecast can you afford to ignore?

Mike Tracey of Sea-3 Inc., the operator of major propane import and wholesale storage facilities in New Hampshire and Florida, noted that the Northeast had pretty normal winters the past few years. Since other regions did not, however, product was always available. A normal winter or colder could be a big problem if it blanketed more than about two-thirds of the country, he suggests.

Rising Demand

Efforts to sway retail customers through the Propane Education & Research Council’s nationwide advertising programs and related promotions have some marketers worried about demand outstripping supply – if there ever is another “normal” winter nationwide.

According to a PERC report presented at NPGA’s Pinnacle conference in June, residential propane consumption is growing most rapidly in the South and the Northeast. From 1998 through 2002, residential propane demand grew by more than 15 percent to nearly 6.9 million households. Market share was down in the South and Southwest in states notably including Texas, Florida and Georgia, but total units were up in those states and regionally. Some 5.7 percent of American households heated with propane in 1990; 6.5 percent did so in 2000.

Tracey says environmental consciousness has driven much of the propane growth in the Northeast. Heating oil is losing market share to propane over concerns about leaking tanks. Propane is popular in rural New England kitchens, too. “Baby boomers like to cook with gas,” he notes.

Gulf coast spot propane prices
Gulf coast spot propane prices

The PERC report also noted that each winter from 1997-98 through 2001was warmer than the 30-year average. “A return to normal long-term weather patterns would increase residential propane consumption by more than 400 million gallons per year,” said the study, written by consultants Energy and Environmental Analysis and Wirthlin Worldwide.

Stock Build

May to September are crucial storage build months. But at 49.1 million barrels in early August, U.S. stocks were still below average, and stood especially low in the Gulf Coast. Since April, stocks grew at a rate 27 percent below the most recent five-year average. By mid-August, inventory hit 51.5 million barrels.

“This was above industry expectations,” said D.D. Alexander of Denver-based Global Gas, an industry wholesaler. “We will need above-average builds every week to get to 60 million barrels by Oct. 1. The only way that will happen is if the petrochemicals stop pulling at record levels and our imports increase significantly. This is possible, but I believe we will struggle to get to 60 million.”

If the 2.3 million barrel build reported for the week of Aug. 11 were sustained for seven weeks, it would add 16.1 million barrels to push storage close to 65 million barrels.

“I don’t believe that we will get to 65-70, which is the figure I think it takes for a ‘normal’ winter,” Alexander says. “If we have a warm winter, it won’t matter what our inventories are. However, if we have a cold winter, 60 million barrels will cause us to have regional supply shortages.”

Tracey said he expects a build to 60 million barrels. Both of Sea-3’s facilities are kept full based on supply less sensitive to market price fluctuations, delivered to them under long-term contracts.

Duke Energy’s Rob Hemsworth says he sees a good chance of just hitting the 60 million barrel mark, provided there is some reduction in demand from the crackers.

U.S. Propane Stocks
U.S. Propane Stocks

“Based on demand growth over the years, I think 65 million would better represent an adequate stock level. It was only one-and-a-half years ago that we went from 70 million to hitting our lower operational limit of around 18 million barrels, although this was due in part to exceptionally strong exports that winter,” Hemsworth says.

Dale Delay, president of Cost Management Solutions consulting firm, notes that while Oct. 1 is the end of the traditional storage season target date, it’s also important to track supplies at Nov. 1 since natural gas looks at their build season to run through Oct. 31.

“We have seen propane inventories build in November in three of the last five years. But the question is, how much can we build by Oct. 1? We have seen some large two-month builds in the last five years,” says Delay, who publishes the Propane Price Insider and other Internet newsletters to the propane industry.

None of those spurts have come in August and September, but in May and June last year 22.3 million barrels of propane were added to U.S. inventories.

“So it is possible for the U.S. to build enough propane by the winter,” Delay says. “We think it is a stretch to get there, though. The largest build in this time frame looking back all the way to 1993 was 9.3 million barrels in 1998. A build like that would put us right at 58.5 million barrels.”

The two lowest end-of-September inventories since 1993 were 51.9 million in 1996 and 59.4 million in 1999.

“We think the 58.5 million barrel number is possible, but it would not be a surprise if we hit 60 million,” Delay added, since in early August Belvieu propane was trading over 80 percent of the value of crude.

“We saw this same type of price relationship in May and June last year when propane inventories recovered so strongly. Price cures a lot problems.”

Riglonal Propane Stocks
Riglonal Propane Stocks

Wholesale Prices

Alexander anticipates this winter’s propane prices will follow crude at 75-85 percent value. She also expects crude, which stood at historically high levels this summer, to stay strong through October.

“Then it will depend on the weather forecasts for winter, as well as terror fears. Many believe that there is a 20-25 percent fear factor built into crude. I don’t think that will disappear before the presidential election,” she says.

December crude futures were trading at $43.90 in mid-August. “If crude maintains it’s current level,” suggests Hemsworth, “we could easily eclipse the $1.26 we saw at TET in February 2003.”

If crude hits $50, “we are looking at.89 to $1.01 propane. We are not that far away,” Alexander speculates. “Today propane is $.87 at Mt. Belvieu and $.92 at Conway. If inventories remain low, we will be more like 80-85 percent of crude values, and with a cold winter, even higher.”

Delay also looks to weather to be key to pricing. He says a normal winter could cause prices to spike drastically at times. But if long-term weather forecasts projecting above-normal temperature in the energy-consuming Northeast/Midwest regions pan out, the picture changes.

“If that were to develop, crude prices could tumble for lack of heating oil consumption and propane would be pulled along for the ride,” Delay says. “

Weather already has had an impact on natural gas production. A cooler-than-normal summer this year reduced demand for natural gas for power generation, Tracey says. In mid-August, natural gas storage stood 233 billion cubic feet above last year.

Still, propane pricing this year is more likely to be pegged to the historically high price of crude, Tracey says.

“We’re going to have to expect to pay much higher prices than we have in the past,” he predicts. If crude settles in at $35, expect $1.70 gasoline and propane at $1.40 to $1.50 retail, he estimates.

Industrial Demand

In 2002, the industrial sector consumed almost 9.6 billion gallons – nearly half of the propane used in the United States. Of that, an estimated 7.8 billion gallons went to chemical plants, while refineries consumer 1.1 billion gallons. Industry also used 1.3 billion gallons for heat and power.

The feedstock market has been the most volatile. As a feedstock on chemical manufacturing, propane can account for as much as 50 percent of the total production cost of the product. As a result, increases in price can substantially reduce demand.

Despite this year’s high summer price levels, feedstock demand remained strong through July and hurt summer storage build. Delay says the relative economics remained attractive to petchems that have the ability to switch to other feedstocks. At less than 75 percent of crude value until August, propane was priced favorably to other feedstocks. That resulted in record petrochemical consumption of propane, close to 400,000 barrels per day.

“Last year, when we saw the strong inventory recovery, propane was trading at around 80 percent of crude valuation and petrochemical demand was around 290,000 barrels,” Delay observed. “If propane trades close to 80 percent of the crude value or better, we believe petrochemical consumption of propane will ease off the recent highs. We still have a strong economy, which increases the demand for petrochemical products.”

But by mid-August there were signs that petchems were reducing their propane draw. “They’re worried about the way the economy is going,” Tracey suggests.

Crop Drying

Another potential factor in the demand situation is the likelihood of a big crop drying year in the Midwest, in particular. “Crops are huge,” Hemsworth says in August. The crop drying demand potential also was high, further complicating the winter heating fuel supply question.

Imports

The Northwest Europe spot price at the end of July this year was only 86.4 percent of the Mont Belvieu price, compared to 92.1 percent last year. Some observers suggested this should have helped to spur U.S. imports.

“Imports have been smaller than expected and the imports we have gotten have been sucked up by high petrochemical demand, causing our inventory levels not to climb like we would like,” Alexander says, “If imports would increase, then I believe we would go down to 75 percent of crude value instead of over 80 percent.”

“Imports will be very important this year in helping replenish stocks,” Hemsworth agrees. “They were critical last year in what was a huge year for imports, with some 26 million barrels coming into the country. Fortunately, this year is on the same pace and ahead on net imports as export volumes are down and the current Northwest Europe/Mt. Belvieu basis is in our favor to keep imports coming at least through the end of the year, barring a strong resurgence in the far East markets.”

Delay says estimates available to him indicated about 4 million barrels of waterborne propane were due in August; another 2 million barrels was expected in September. “We think that can get ramped up some, if propane maintains this strong value spread to crude,” he says.

Pre-buys

So what were your fellow marketers doing this summer – buying early or waiting for lower prices?

Duke’s Hemsworth says he was dealing with some marketers who sat on their empty storage tanks until August. With crude prices still rising past historic highs, they eventually concluded they should not wait any longer to pre-buy propane.

“With crude hitting $45, I think they’d had enough,” he says. “It was pretty scary.”

Energy Information Agency forecasts projecting high crude prices through 2005 didn’t ease that fear. Even that projection was not enough to prompt most marketers to pay summer wholesale prices that make veteran propane marketers wince, however. Marketers are bracing themselves for the likely storm of protest they’ll hear from customers if those prices don’t ease off before the winter heating season begins.

“A few have stepped up and bought pre-buy for winter or for September/October demand,” reports Alexander. “But most are watching from the sidelines, reluctant to buy in case the market comes off this winter. The majority are just sitting there, saying, ‘I don’t know what to do.'”

Holding off purchases at the high wholesale prices that prevailed this summer was more prevalent in the Northeast and Southeast markets, Delay observes. In the Midwest, where summer was a little cooler than usual, there were reports of “a little stronger pre-buy demand.”

In mid-August, Hemsworth estimated that refilling at the retailer and customer levels was running some 50 percent behind where they would normally be at this time.

“I think most retailers have been keeping their tanks low, and customers who have the option are keeping their tanks low,” adds Alexander. “This is a bad combination, along with little pre-buy gas bought. It has been several years since we have gone into winter with the retailers not owning a significant portion of their winter product.”

Delay agrees. “Our sense is pre-buy storage is substantially behind previous years. If this is just a normal winter, we could experience some tough price spikes. The industry infrastructure is bottlenecked at the secondary storage level. Without a lot of gallons in the field, cold weather could result in some tough problems this year.”

He also referenced a 2001 Purvin and Gertz study that found about 137 million barrels of primary storage in the U.S. infrastructure. Secondary storage was calculated to be 9.2 million barrels, and end-use storage at 111 million barrels.

“We believe that is the biggest infrastructure impact in our industry today,” Delay says.

Retailer and customer reluctance to fill tanks at the summer’s high prices is understandable, but if an early winter shows up everyone may be scrambling. If reluctance to fill continues into cold weather, “dealers will be making more deliveries but demand may be stable,” since customers will request limited quantities that stay within their monthly budgets, Tracey predicts.

If a normal winter does not make an appearance, he expects wholesalers with major product stored in Harris County, Texas to try to empty their storage in December to avoid year-end county taxes there. In that scenario, that will be the moment when “prices will fall like crazy.”

Consumer Prices

A Massachusetts retail propane survey found an average retail price on July 1 of $1.60 – up significantly from $1.43 the previous year and $1.28 in 2002. At Belvieu and Conway, wholesale prices rang up at around 90 cents.

A whole new level of wholesale and retail pricing seemed to be in effect. But there were beginning to be some signs of consumer price resistance.

“This summer we saw a lot of resistance on heating swimming pools on the East Coast. Once we get into winter, I’m sure we will see more conservation on heating requirements than ever before,” Alexander says.

“It keeps me awake at night wondering how consumers are going to pay for the propane.”

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