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Trader's Corner
This week’s Trader’s Corner looks at the price difference between Belvieu and Conway.
Economics 101 teaches us that the price of a commodity in a free-market system is set by supply and demand. Let’s look at the inventory positions in the Midwest and on the Gulf Coast, followed by their relative values, and then ask a question.
The top chart (click to enlarge) shows Gulf Coast inventory near its five-year high. The middle chart shows Midwest inventory near its five-year low. Yet the bottom chart that compares the price of the two shows Belvieu (the Gulf Coast market) trading at a higher price than Conway (the Midwest market).
Certainly inventory must matter because Conway/Midwest propane was trading 20 cents below Belvieu/Gulf Coast barrels at this time last year when the Gulf Coast and Midwest were carrying high inventory. Then as Midwest inventory surpluses were eliminated the spread dropped all the way to Conway trading at Belvieu minus 2.75 cents. But then the spread leveled out around 5 cents. So far in 2013 Conway has traded at Belvieu minus 5.148 cents.
Here is the question: Why did the price level out at this point? If Midwest inventory is below normal and Gulf Coast inventory is above normal, why isn’t Conway trading higher than Belvieu?
We ask those questions to point out a bit of a fallacy that has developed in our industry. We tend to equate inventory with supply. If inventory is low, we think supply must be tight. But in reality more robust supply means there isn’t as great of a need to carry high inventory positions. For example, if you know there is going to be tight conditions from your supply sources, you may fill your bulk tank to the brim. But, if you know ample supply is available in your area, the pressure to hold a lot of inventory is reduced.
That is exactly what is occurring in the Midwest. Let’s look at propane production from the Midwest (PADD 2) and the Rocky Mountains (PADD 4), which feed into Midwest/Conway supplies.
Propane supply coming from natural gas processing plants that feed the Midwest has gone from about 56 million barrels in 2007 to more than 90 million barrels in 2012. That is about a 64 percent increase in five years. We are betting that few propane retailers have seen a 64 percent increase in demand in the last five years, assuming their customer base is the same size.
With so much supply in the region, the need to carry high inventory isn’t as critical given that demand has not increased in lockstep with supply. A producer can’t really expect to store and sit on a lot of inventory, hoping that tight supply/demand conditions will occur and provide a windfall. That used to be the case in the Midwest, but the paradigm has shifted.
Granted, with inventory positions pulled down, there is a greater possibility that should a strong crop-drying or winter-demand period occur Conway could price equal to or even higher than Belvieu for a short period. But the reality is the supply in the region could adapt and fill just about any temporary high demand in the Midwest, meaning the upside gain for propane held in inventory is limited.
As a result, producers are working hard to bypass the necessity of moving their propane into Conway storage. Instead, they are moving as much product as possible directly to the higher-valued East Coast and Gulf Coast markets.
The price of Conway is not a reflection of inventory, as much as it is a reflection of where it must be priced to move into these markets. That is why we are seeing Conway leveling out around Belvieu minus 5 to 10 cents.
Given the new lower inventory levels, the probability that local demand will push Conway prices up against Belvieu is increased. But the true supply/demand picture suggests those times will become further and fewer between and likely last only briefly.
The simple fact is that a producer would lose a lot of money holding huge inventory positions in Conway, waiting for those days. Higher supplies and static storage capacity make storing propane all the more expensive. The better returns will come by getting propane directly to higher-demand markets and nearer petrochemical plants and export facilities.
That is exactly what has been occurring, especially over this last year. That is why pricing and inventory positions are looking considerably different than they did at this time last year.
If you are going to focus on inventory, we suggest looking more closely at total U.S. and Canadian inventory rather than worrying too much about the regional inventory conditions. The supply imbalance has caused the industry to get production areas much better connected to supply areas, making regional inventory positions less critical than in years past.
Call Cost Management Solutions today at 888-441-3338 for more information about how Client Services can enhance your business, or drop us an email at info@propanecost.com.
WEEK IN REVIEW
Crude and refined products moved higher as they had a bit more fundamental support.
Propane felt weak as it struggled to stay near neutral despite gains in crude and products.
We start the week neutral primarily on the momentum in crude despite propane feeling a bit more bearish.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: An announcement by Iran that it plans to build a nuclear reactor next year and a disruption in production from a key North Sea crude field sent crude higher. Belvieu propane moved up with crude, though it failed to match crude’s full move. Conway was unchanged.
Tuesday: Reports that U.S. factory activity contracted during May more than offset a report that chemical weapons had been used during fighting in Syria to send crude down slightly. Conway was once again unchanged, while Belvieu outpaced West Texas Intermediate (WTI) crude to the downside.
Wednesday: A 6.3-million-barrel draw in U.S. crude inventory sent crude prices higher. Propane was not attracting many buyers despite a below-average build in inventory. Belvieu managed to stay even to Tuesday’s close with a build of just 0.2 million barrels in Gulf Coast inventory. But Conway lost ground on an inventory build that was about 50 percent higher than the five-year-average build for week 22 of the year.
Thursday: Conway recouped its losses from Wednesday and Belvieu matched a 1.1 percent gain in WTI crude. A sharp drop in the U.S. dollar following a decision by the European Central Bank to not provide more stimulus for the Eurozone economy was the key driver behind more buying of crude.
Friday: It was a strong day for commodities and equities markets as jobs reports in the U.S. and Canada encouraged investors to take on more risk.
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