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Trader's Corner
This week’s Trader’s Corner looks at the alarming drop in Midwest propane inventory.
Midwest propane inventory has dropped quickly in the past eight weeks, causing a sharp rise in Conway propane prices. In fact, Conway is now trading at a substantial premium to Belvieu propane.
The red line in the chart above is this year’s price spread or difference between Mont Belvieu and Conway. It is not unusual for Conway to have a premium at this time of year because it is more influenced by crop drying and weather than is Belvieu.
However, the level of the premium (around 10 cents) is significantly more than the five-year average. As the five-year high/low (gray area) shows, the spread still has the potential to get worse, but we are talking extreme conditions for the spread to increase beyond the present level.
The spread has developed as a result of a sharp drop in Midwest propane inventory.
For weeks, Midwest propane inventory has been setting new five-year low marks. We did not find the low inventory position this summer surprising because, with more Midwest production, producers would see less opportunity in carrying high Midwest inventory. But of course, as fate would have it, demand conditions have quickly tested the idea that lower inventory positions could be carried.
During the last eight weeks, over which inventory has been dropping, 7.370 million barrels have been pulled from inventory. If we project out that same rate of draw over the next 16 weeks (end of March), Midwest propane inventory would be down to just 2.206 million barrels.
If the same rate of inventory draw is projected through the rest of winter, Midwest inventory would easily set a new end-of-winter low inventory mark. That possibility is providing price support at the moment.
Of course, crop drying is out of the way and that was a big factor in taxing inventory levels. It is also possible that the worst heating-demand conditions are already behind the market.
The above temperature forecast map from the National Oceanic and Atmospheric Administration covering the first quarter of next year shows equal chances of above, normal and below normal temperatures in much of the high-demand areas, including those that are dependent on Midwest supplies. Obviously that is a broad range, but at least for now there is not a high probability of below-normal temperatures.
Also, refineries have completed all of their maintenance for the year and should be producing the maximum amount of propane for the remainder of winter. With the high upgrade for extracting propane, we know that gas processors will be squeezing every drop of propane out of the natural gas stream.
And of course, the premium at which Conway is trading will encourage producers to keep barrels in the Midwest where possible.
A limitation to U.S. supply is the premium at which Sarnia and Edmonton are trading over Conway and Belvieu propane. Sarnia is at 175 cents, Edmonton 160.5625 cents, Conway 141.125 cents and Belvieu 131 cents. That is likely to keep U.S. propane imports at a minimum. And currently the value of U.S. propane is still far enough below the world market to keep exports high. Northwest Europe, for example, is around 185 cents.
The present inventory position in the Midwest is concerning. A retailer must guard against a continued spike in prices. However, the possibility remains of getting too long supply at the current elevated prices.
Call options can be good risk management tools under these types of situations. We suggest checking the premium on call options when considering taking a purely long position by buying swaps or entering pre-buys. If you are already long supply, this might be an excellent time to protect gains by buying put options. You might find option premiums acceptable given the potential for big price swings in either direction from here. Options save us from having to guess right on how winter weather will play out – a tough guess in the best of circumstances.
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
Propane prices continued their surge on cold weather and tight inventory during the first three days of the week, but were essentially flat over the last two days of the week. The loss of momentum will have us neutral to start the week. Crude was struggling to find buyers ahead of this week’s Fed meeting.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: Propane prices continued to run higher with low inventory and winter weather in support. Crude fell on plenty of global crude supply, but the downside was limited on word that TransCanada had begun filling the southern leg of its Keystone XL line over the weekend.
Tuesday: More big gains for propane, especially at Conway, ahead of Wednesday’s inventory report. News that the Organization of the Petroleum Exporting Countries held production below its 30-million-barrels-per-day limit and prospects that a new crude line would pull Cushing, Okla., crude inventory lower pushed crude higher.
Wednesday: The U.S. Energy Information Administration reported a 1.5-million-barrel draw in Midwest propane inventory, sending Conway up sharply for the third day in a row. The upside in Belvieu was limited due to a slight build in Gulf Coast inventory. Crude inventory fell 10.585 million barrels, but prices slipped after it was announced a U.S. government budget deal had been reached. Big builds in refined products inventories and a build in crude inventory in Cushing worked against crude buyers as well.
Thursday: The upward momentum in propane prices slowed despite heavy trading volume. Worries about what the Fed would do with monetary policy at its meeting next week limited upside for crude.
Friday: Propane prices remained subdued to finish what had been a bullish three days to start the week. Crude also struggled to find buyers, as investors remained cautious ahead of the Fed meeting.
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