Propane Price Insider
  
ppi ppi ppi ppi
ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi
ppi

Click Here!

Click Here!

Click Here!

Click Here!

ppi ppi ppi ppi


 

Click here for a free, 10-day trial of The Propane Price Insider!

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.

Trader's Corner

This week’s Trader’s Corner looks at the benefit of using options in an unpredictable market.

As you will recall last week in Trader’s Corner, we looked at the Federal Reserve, the tools it uses to support the economy and control inflation, and discussed why the potential for unwinding the stimulus measures currently employed by the Fed caused commodities and equities markets to drop so severely.

West Texas Intermediate (WTI) crude dropped from $99.01 to $92.67 in a matter of three days after Federal Reserve Chairman Ben Bernanke said the Federal Reserve could start tapering down its bond-buying program later this year. The Dow Jones Industrial Average dropped from 15,332 to 14,551 over four days.

Since then, markets have rallied as several Federal Reserve Bank presidents have assured markets the Fed will not roll back its stimulus measures until data shows the U.S. economy can sustain its recovery without the Fed’s stimulus. Crude is back to $97.15 and the Dow is at 15,024.

If all of this volatility and uncertainty were not enough, propane became totally disconnected from the general market. Propane had been going down in the period before the Fed meeting, while crude had been going up. After the Fed meeting, when crude was going down, propane rallied for a couple of days. Then, when crude began its rebound, propane prices lost their upward momentum and have generally drifted sideways.

All of these gyrations in the market make any investor uneasy and unsure. As propane retailers, we are also investors. Most of us invest in our winter supply needs at some point during the summer. With all of the market uncertainty, decisions on when and how to invest in our future supply needs are difficult.

When we are unsure, we often do nothing. Unfortunately there is a lot of risk to doing nothing. If we don’t invest in winter supply, in what appears to be a fairly good buying environment for propane, we are at risk of propane prices going higher. If we don’t buy supply, we avoid supply-side risk, but we take on market risk. If our competitors have taken advantage of a good buy point and we don’t, we run the risk of losing customers next winter because we are not priced competitively. Or, if we keep our prices low to avoid losing customers, we see our operating margins shrink. Neither losing customers nor having to suffer through a period of low profit margins is good for the health of our business – not to mention our own personal health.

Sometimes the best way to manage these risks is to pay someone else to assume them. We do this all the time in our propane business through insurance. We insure just about everything in our business – from trucks, to buildings, to employee health care. If we are going to insure most everything else, it probably makes sense to consider insuring against the risk of price volatility in the product we sell.

We can transfer the risk of supply by the use of options. Most propane retailers are positioned to be at the greatest risk to rising prices. That is because we don’t own the product we are going to sell in the future. On the other hand, if we have bought supply, we are at risk to falling prices. Our focus today will be on transferring risk to rising prices.

To transfer risk to rising prices, a propane retailer would take an option on propane at a specific price. The particular option he would take would be a call option. For a premium, a call option provides the right to buy propane at a particular price in the future. That price is known as the strike price.

In the future, if the price of propane were higher than the strike, a holder of the option would exercise it. If the future market price were lower, he would not exercise the option.

The company we would use to insure us sets the strike price. However, it uses propane futures curves with a heavy influence from crude futures. We put these kinds of curves out in our daily report.

We spoke with an option writer as we prepared this article. I asked him for the strike for this winter (October-March) call option. The strike for Conway was 85 cents and Belvieu 88 cents.

For simplicities sake, I had the entire winter averaged into one strike price, but I would actually own six different options, one for each month. Since I was going to have the same volume on each option, the average was easy to calculate. For discussion purposes, let’s assume I own an option on 100,000 gallons each month, October through March, for a total of 600,000 gallons in options. Again, for simplicities sake, let’s use Conway as the place we will hold the option. The discussion would apply the same to Belvieu. You would buy a Conway or a Belvieu option depending on which market is the basis for the price of propane in your market.

So our first option is on 100,000 gallons of Conway October propane at a strike of 85 cents. At the end of October, when the monthly average for October is known, the monthly average will be compared to the strike price. If the monthly average is greater than 85 cents, we would exercise our option and the option writer would pay us the difference between 85 cents and the monthly average. If the monthly average is equal to or less than 85 cents, we do not exercise the option and nothing happens. This process is repeated for each of the remaining winter months from November through March.

Like insurance companies, option writers do not assume risk for free; they charge a premium. The average premium of the six Conway options we would own is 8.5 cents. When we buy the options, we would write a check for the premium and send it to the option writer. On 600,000 gallons, the premium would be $51,000.

By holding the options, a retailer knows 85 cents is the highest cost of propane for him FOB in Conway, Kan. He knows the cost of having that price is 8.5 cents. We add the premium to the strike to get the total cost of that supply, which is 93.5 cents.

For the option to be useful, the retailer needs to know what his supplier usually charges him over Conway at his local supply point. Let’s say that a review of what we paid to our supplier shows the most we ever paid was Conway plus 20 cents. To be safe, we will use the 20 cents to help establish our sales price.

Combining the strike (85 cents), the option premium (8.5 cents) and the difference between our local market and Conway (20 cents) equals 113.5 cents. We would add our desired margin to that number. Let’s say 50 cents. We can now offer 163.5 cents with confidence we can meet that commitment and earn 50 cents per gallon while doing it.

No matter how high the cost of propane goes in Conway during October, we use the numbers above for establishing our cost of supply and sales price. Conway goes to 125 cents in October? No matter, we are selling at 163.5 cents.

The great thing about an option is that it not only caps our cost of supply, it allows us to lower our prices to remain competitive. Let’s say prices in October are running at a level they will likely average 75 cents in Conway. Obviously we are not going to exercise an option to buy 85 cents propane when we can buy Conway at 75 cents. Still, we have the cost of the option, which doesn’t go away. It must always be baked into the supply cost cake.

Nevertheless, we can lower our street price by 10 cents to make sure we stay competitive with the local market. We still make our 50-cent margin. Conway (75 cents), supplier difference (20 cents), option premium (8.5 cents) and total supply cost (103.5 cents) equals our street price of 153.5 cents.

Obviously the disadvantage here is that if our competitors did not buy options they are always 8.5 cents better than us in a falling market. So the primary question when deciding on options will be: Can I remain the cost of the option above my competitors in a falling market and not lose customers?

Options give a retailer a tremendous amount of certainty in his sales price structure. Most importantly, they give him a lot of control over his margin in both rising and falling price conditions. They can provide tremendous advantage in a sharply rising market and allow him to remain competitive in a falling market.

In our hedging seminar in August, we will go over many examples of how options work and how they can be used to the advantage of a retailer and his customers.

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 had a solid rebound after Federal Reserve Bank presidents reassured markets that they would not end stimulus measures before the market was ready.

Propane could not keep up with crude as trading volume really slowed following a spike in activity the previous week.

We go into the week neutral. Even though crude has momentum, fundamental data has not been supportive for propane.

LAST WEEK'S DAILY HIGHLIGHTS
Monday: It was a volatile trading session, with markets going down early. But crude turned sharply higher and stayed strong through the close on word some Canadian crude export lines to the U.S. were closed after flooding caused damage.

Tuesday: The upward momentum in propane finally cooled as trading volume dried up. Central banks tried to calm markets, taking away some of the fear that stimulus measures would be removed too quickly.

Wednesday: Crude and Belvieu propane moved lower following bearish Energy Information Administration (EIA) inventory reports. The EIA report was more supportive for Conway propane, which moved higher.

Thursday: Reversal of fortune for propane as Belvieu regained the 1 percent lost on Wednesday, while Conway gave up the 0.625 cents it had gained on Wednesday.

Friday: Conway managed to post a gain to close the week, but Belvieu and crude edged lower on end-of-quarter book squaring.

ppi ppi ppi ppi

LP Gas Magazine is also on Facebook and Twitter

facebooktwitter

Click Here!

Click Here!

Click Here!

Click Here!

ppi
ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi ppi
ppi ppi ppi ppi ppi


COST MANAGEMENT SOLUTIONS
Cost Management Solutions LLC (CMS) is a firm dedicated to the analysis of the energy markets for the propane marketplace. Since we are not a supplier of propane, you can be assured our focus is to provide an unbiased analysis.

Market Information Services
The Propane Price Insider, an e-mail service that provides:

  • Three Daily Price Flash Wires
  • Periodic Option Quotes
  • Wednesday Inventory Data Updates around 11 a.m. ET
  • Evening Report with Executive Summary, Trader's/Hedger's Corner, Weather maps and complete review of energy prices that are based on Propane's Btu Equivalent

Free trial!
For a free 10-day trial subscription by e-mail, sign up online here or call toll-free at 888-441-3338.

Client Services
Many retailers simply don't have time to analyze the large amounts of data to make an informed purchasing decision.

We offer:

  • Detailed market recommendations on hedge and pre-buy entry points
  • Prompt market execution of hedging strategies
  • Supply cost analysis and recommendation as to effective hedging strategies
  • Because of the volume of transactions we place annually, we receive large volume consideration when we place your hedges

Visit us online at www.propanecost.com. Or e-mail info@propanecost.com.

Contact us today to see if you can benefit from having the Energy Price Watchdog working for you.

Dale G. Delay 888-441-3338, ddelay@propanecost.com
Mark Rachal  318-865-9928, mrachal@propanecost.com

ppi ppi ppi ppi ppi

LP Gas Magazine
www.lpgasmagazine.com

For advertising information, contact:
Brian Kanaba, Publisher
bkanaba@northcoastmedia.net
216-706-3745


You are currently subscribed to Propane Price Insider as %%EMAILADDR%%.

Forward to a friend  | Change your subscription preferences  |   New subscriber sign-up
If you wish to leave this mailing list, simply unsubscribe. | Refer to our Privacy Policy.

LP Gas Magazine is a division of North Coast Media LLC.
1360 East 9th St., Suite 1070, Cleveland, Ohio 44114
© 2013 North Coast Media. All Rights Reserved.
Reproduction in whole or in part is prohibited without written permission.