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Trader's Corner
This week’s Trader’s Corner looks at some of the tools we can use to manage supply.
Last week, we were watching coverage of the first round of the NFL draft. Teams are in the process of filling out their rosters for next season. They hope during this offseason to assemble a group of players that can effectively compete with the other 31 teams in the league. Perhaps the 53 players they can have active for each game day are talented enough to win a Super Bowl.
There were many different strategies being used during the draft. Some teams were drafting to fill immediate needs, while others were looking to draft the best available player with their pick. Some teams were trading up to get what they believe are the most talented players, while others were trading down to get more players.
Throughout the process, teams gathered a lot of information on all of the players they considered drafting, hoping it would lead to good decisions. Still, they know a player might not always turn out as good as hoped.
As propane retailers, we are beginning to move into our “draft” as well. Most of us are putting the finishing touches on this season and beginning to turn our attention to next year. We will fill out our supply “roster” with purchases to fill specific needs. But we may also make purchases when we believe the best buys are available, even though we don’t have a specific need at the moment.
We will begin gathering information, make the best picks we can and hope to field a competitive supply portfolio next winter. With luck, perhaps we will field the best supply portfolio in our market area and win the super profit-margin bowl.
So let’s talk a little draft strategy. Most of us have specific needs for which we need to buy. Perhaps we have industrial customers that consume fairly steady volumes and most desire a known price so they can hit their budgets. For them, we want to offer a fixed price. The best supply tools for meeting those customers’ need for a known price are a pre-buy or a swap.
Some of us will offer cap programs, which are important to many individuals trying to juggle family finances. Many want to know their propane bill is not going to crash the family budget, resulting in canceled vacation plans or other activities they would rather use their money to enjoy. But they would also like a little windfall should prices fall. For cap programs, a call option is our best tool. It has a premium cost that must be rolled into the price charged the customer. But it allows the customer to have a worst-case cost of propane and possibly have a lower price if prices go lower.
Budget programs are also great for helping families manage their finances. Budget programs also give us the most flexibility in managing the supply side of our business. We set our budget prices and then can buy when the market gives us the opportunity to hit our margin targets. Plus, we get the added benefit of being able to have greater control of physical deliveries.
Of course, most of us still sell many of our gallons outside any type of fixed price, budget or cap program. We are going to buy supply, put a margin on it and offer it to our customers. If we have done a good job, we will position ourselves to offer customers a price that is competitive within our local market. It is nice to have supply that is cheaper than our competition (win the super profit-margin bowl), but the most important thing is to always be competitive. We never want to be forced to maintain a price so much higher than our competitors that it drives away our customers or forces us to cut our margins to keep customers.
Many of us sometimes feel the best way to do this is to do nothing in advance on the supply side. It feels safe to buy at the rack, add our margin and sell it. But we are asking the customer to assume all of the price volatility, which may not be safe for us at all. If our competitors have found opportunities to “draft” lower-cost supplies during the year, our strategy of “picking up free agents” may be a bust, making us uncompetitive.
We must understand that risks can’t be avoided; they can only be managed. While we may avoid supply price risk by buying at the rack price, we still risk losing customers by hitting them with sticker-shock propane bills. If you force your customers to assume all of the price risk, they will be forced to manage it, and their decisions may not include your company.
Frankly we are in a better position to manage price volatility than our customers, and if we do not then our company will struggle to remain viable in the long run.
The problem for most of us is “pick phobia.” Despite our information gathering, we are frozen when it comes time to pull the trigger on supply, even when it appears to be the right decision. We get a terrible case of the “what ifs” at the critical time of decision, and many good opportunities pass us by.
Pick phobia is generally exacerbated by the desire to buy at the best price of the year. If that is the goal, one almost never does. A famous Prussian general is quoted as saying, “The greatest enemy of a good plan is trying to have the perfect plan.” This general knew there was no such thing as a perfect plan because there are too many variables once the plan is put into action.
So the first step in getting over pick phobia is to have a realistic goal. A realistic goal is to make sure you are always competitive in your marketplace.
The chart above (click to enlarge) shows the latest U.S. propane inventory position. If we completely ignore the trend that is removing propane surpluses and, at least for now, pointing to below-average inventory before next winter, we may be uncompetitive with a buy-at-the-rack-price strategy.
But what if the trend changes? What if supplies start building? What if the economy tanks? Here is the deal. We must plan around what the market is telling us today. Then we must react to the “what ifs” as they occur, once our plan is rolled out.
Based on the current inventory trend, marketers should be long supply for next winter. So let’s say they use a combination of swaps and pre-buys to manage the risk of higher prices in an effort to “make sure we are competitive” next winter. If the inventory trend changes, the economy begins to tank or other things happen, we can adjust. If we bought a swap, we can sell a swap to close the position. If we bought a pre-buy, we can sell a swap or buy a put option if we think the pre-buy is becoming a liability.
Some of the decisions we make will be right. Some of the decisions we make will be wrong. When we reverse our decision, it may cost us a little. But the key is to avoid any scenario where we won’t be competitive.
With that goal in mind, we become managers of risk. We will always field a competitive supply portfolio. We will help our customers manage price risk. We will consistently keep our company in good position and always keep moving forward.
We greatly enhance our chances of winning a super profit-margin bowl if we are consistently fielding a competitive supply portfolio each year.
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 recovered, with threats to supply trumping weak fundamentals.
Propane lagged the gains in crude but continued to find plenty of support from the current inventory trend.
We went bullish on Thursday and will remain so to start this week.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: Crude and propane were up, trying to rebound from the previous week’s losses. Issues with a crude pipeline from Sarnia, Ontario, Canada, to Indiana were supportive of crude, but a decrease in U.S. existing home sales for March limited the upside.
Tuesday: Risk to crude supplies helped crude prices shake off weak factory activity in Asia and Europe. Propane was bearish ahead of the Energy Information Administration (EIA) inventory report, which was a bit surprising given the support the inventory trend had been.
Wednesday: Propane revised Tuesday losses after the EIA reported a small draw on inventory in a week that normally has a million-barrel build. Crude got support from a sharp drop in gasoline inventory. It seemed that investors were moving money from equities after weak U.S. durable goods orders, with crude benefiting.
Thursday: More strong gains in crude and propane. Crude took out numerous technical resistance points. An acknowledgement by the U.S. that Syria may have used chemical weapons against rebels was the key support.
Friday: The rally in crude and propane slowed as crude traders took profits. Still, propane held up against the fall in crude and Conway was trading higher at the close.
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